CSA
Summary
Read the report at California State Auditor ↗
Workers’
Compensation
Fraud:
Detection and Prevention Efforts Are
Poorly Planned and Lack Accountability
April 2004
2002-018
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April 29, 2004 2002-018
The Governor of California
President pro Tempore of the Senate
Speaker of the Assembly
State Capitol
Sacramento, California 95814
Dear Governor and Legislative Leaders:
As required by Chapter 6, Statutes of 2002, the Bureau of State Audits presents its audit report concerning the
effectiveness of the Fraud Assessment Commission (fraud commission), the Fraud Division, the Department of
Insurance, the Department of Industrial Relations (Industrial Relations), and local law enforcement agencies in
identifying, investigating, and prosecuting workers’ compensation fraud and employers’ willful failure to provide
workers’ compensation benefits for their employees.
This report concludes that although employers are assessed annually to pay for efforts to reduce fraud in the
workers’ compensation system—an amount that has averaged about $30 million per year for the past five
years—the fraud commission and the insurance commissioner have not taken adequate steps to measure fraud
in the system, develop a strategy to reduce it, or ensure that the fraud assessment funds are distributed to most
effectively investigate and prosecute workers’ compensation fraud. Because the Department of Insurance’s
Fraud Division (fraud division) does not conduct adequate strategic planning, it does not allocate a sufficient
amount of its resources to meet its noninvestigative responsibilities, including those relating to researching and
reporting on the level and affects of fraud in the system and monitoring county district attorneys’ compliance
with the requirements of the workers’ compensation antifraud program and insurers’ compliance with suspected
fraud-reporting requirements. Improvement is needed in sharing information between Industrial Relations and
the fraud division to identify potential workers’ compensation fraud. Industrial Relations has not implemented
three statutory programs intended to identify employers who fail to provide workers’ compensation insurance or
benefits for their employees; implement a protocol for reporting medical provider fraud; and to annually warn
employers, claims adjusters and administrators, medical providers, and attorneys who participate in the system
about the legal risks associated with committing workers’ compensation fraud.
Respectfully submitted,
ELAINE M. HOWLE
State Auditor
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CONTENTS
Summary 1
Introduction 13
Chapter 1
Workers’ Compensation Antifraud Efforts Lack
Adequate Planning and Coordination, and Funding
Is Not Determined Using Established Priorities 25
Recommendations 53
Chapter 2
Lacking Adequate Strategic Planning, the Fraud
Division Has Not Met All Its Responsibilities for
the Workers’ Compensation Antifraud Program 57
Recommendations 80
Chapter 3
Efforts to Detect and Prevent Workers’
Compensation Fraud Are Inadequate and
Lack Cooperation Between Agencies 83
Recommendations 102
Appendix A
Recommendations From Various Entities for
Antifraud Grants to District Attorneys 107
Appendix B
The Fraud Division’s Referral Form for Suspected
Fraudulent Claims 109
Responses to the Audit
Department of Insurance 113
California State Auditor’s
Comments on the Response
From the Department of Insurance 131
Fraud Assessment Commission 135
California State Auditor’s
Comments on the Response
From the Fraud Assessment Commission 143
Labor and Workforce Development Agency 149
California State Auditor’s Comments on
the Response From the Labor and
Workforce Development Agency 155
California State Auditor Report 2002-018 11
SUMMARY
RESULTS IN BRIEF
The Fraud Assessment Commission (fraud commission)
and the insurance commissioner have not adequately
Audit Highlights . . .
implemented a strategy to ensure that funds assessed
Our review of the State’s against employers—averaging approximately $30 million for
program to reduce workers’ each of the past five years—are required and are used in the
compensation fraud
most effective manner to reduce the costs that fraud adds to
revealed that:
the workers’ compensation system.
þ Although employers are
assessed annually to pay
The California Constitution authorizes the Legislature to create
for efforts to reduce fraud in
and enforce a workers’ compensation system that requires
the workers’ compensation
system—an amount employers to compensate workers for job-related injuries and
that has averaged about illnesses. Employers must pay for these benefits to injured
$30 million per year for the
workers either by purchasing workers’ compensation insurance
past five years—the Fraud
from an insurer or directly through self-insurance. The total
Assessment Commission
(fraud commission) and cost of California’s workers’ compensation system has more
the insurance commissioner than doubled recently—growing from about $9.5 billion
have not taken steps
in 1995 to about $25 billion in 2002—giving rise to sharp
to measure fraud in
the system or develop increases in employers’ workers’ compensation insurance
a statewide strategy to premiums and prompting several efforts to reform various
reduce it.
aspects of the system. Some of these reform efforts have been
þ Neither the fraud targeted at combating the fraud alleged to exist in the workers’
commission nor the compensation system, including fraud perpetrated by workers,
insurance commissioner medical and legal providers, insurers, and employers.
has acted to ensure that the
assessments employers pay
are necessary or are put to One of the reform efforts, Senate Bill 1218 passed in 1991, created
the best use for reducing an annual assessment collected from employers and paid into a
the overall cost that fraud
fund dedicated to increasing the investigation and prosecution
adds to the workers’
of fraud in the workers’ compensation system. This legislation
compensation system.
also established the fraud commission, which is responsible for
þ Shortcomings also exist determining the annual assessment after considering the advice and
in the process used to
recommendations of the Department of Insurance’s Fraud Division
distribute fraud assessment
funds to county district (fraud division) and the insurance commissioner.
attorneys in a way that
maximizes their effectiveness
However, neither the fraud commission nor the insurance
in fighting fraud.
commissioner has acted to ensure that the assessments
continued on next page employers pay are necessary or are put to the best use for
reducing the overall cost that fraud adds to the workers’
compensation system. Specifically, no meaningful steps
have been taken to measure the extent and nature of fraud
in the system. Instead, the fraud commission, the insurance
California State Auditor Report 2002-018 11
þ Because the fraud division commissioner, and the fraud division rely primarily on
has not conducted anecdotal testimony from stakeholders in the workers’
adequate strategic
compensation community, unscientific estimates, and
planning, it has not met
descriptions of local cases involving fraud included in county
all its noninvestigative
responsibilities and spends district attorneys’ applications for antifraud program grants.
a significant portion of The Coalition Against Insurance Fraud has pointed out that the
its workers’ compensation
most common rationale for measuring fraud is that finding an
antifraud resources
investigating suspected effective solution to the problem requires knowing its extent.
fraud referrals that do According to the fraud division chief, lacking the necessary
not result in criminal
resources and expertise, the fraud division cannot measure the
prosecutions by county
extent and nature of fraud in the workers’ compensation system
district attorneys.
or determine the effectiveness of activities to deter it.
þ The fraud division does
not facilitate an effective
Additionally, neither the fraud commission nor the insurance
system to obtain referrals
of suspected fraud commissioner has made a meaningful effort to establish baselines
from insurers and for measuring the current level of fraud and gauging future
other state entities
changes in that level. If baselines were available, it would
involved in employment
be possible to systematically and periodically measure the
related activities.
level of fraud, using available data, to determine the effectiveness
þ The fraud division’s of programwide strategies in reducing fraud in the workers’
special investigative audit
compensation system. Instead, the fraud division collects and
unit lacks a program
that effectively targets publishes discrete statistics showing the number of investigations,
insurers to achieve arrests, convictions, and restitutions; revealing only that some
maximum compliance
sources of fraud may have been removed, not whether antifraud
with suspected fraud
efforts are cost-effective—that is, whether they have reduced the
reporting requirements, a
standardized approach to overall cost that fraud adds to the system by as much or more
conducting audits, timely than what is spent annually to fight it.
reports and follow-up,
and effective penalties to
Further, the fraud commission and the insurance commissioner
promote compliance.
have no overall strategy for using the funds assessed against
þ Improvement is needed
employers to reduce fraud in the workers’ compensation
in sharing information
system most effectively and efficiently. Such a strategy could
between the Department
of Industrial Relations be translated into the goals and objectives, priorities, and
(Industrial Relations) measurable targets that state and local entities involved in fraud
and the fraud division to
reduction efforts need to work effectively. These systemwide
identify potential workers’
goals and priorities could be broken down into regional
compensation fraud.
elements to accommodate any unique regional fraud problems.
þ Industrial Relations has
Having a measured level of fraud and a strategy for combating
not implemented three
it could provide the fraud commission with criteria to use in
statutory programs
intended to identify arriving at the appropriate assessment to be paid by employers
and prevent workers’ each year and in allocating the fraud assessment funds to state
compensation fraud.
and local entities that are considered most effective in the efforts
to reduce fraud.
22 California State Auditor Report 2002-018 California State Auditor Report 2002-018 33
þ The formulas Industrial To assure California’s employers that their fraud assessment
Relations uses to calculate has been effectively used to reduce the amount of fraud and
and collect the workers’
thereby reduce the overall cost of the workers’ compensation
compensation fraud
system, the fraud commission and the insurance commissioner
assessment surcharges
have, in recent years, need (1) a systematic effort to measure the extent of workers’
consistently resulted compensation fraud in the system and the types of fraudulent
in insured employers
activities most responsible for driving up premiums, (2) an
being overcharged.
overall strategy to combat them, and (3) a means to periodically
þ Although Industrial evaluate the effectiveness of the efforts (at both the state and
Relations suspects that
local level) to reduce the occurrence of those types of fraud.
some insurers do not
Neither the fraud commission nor the insurance commissioner
report and remit all of the
fraud assessments they has met these three requirements. Simply put, they cannot
collect from employers, justify the amount employers are assessed each year to combat
it states it does not have
fraud. According to some members of the fraud commission, one
the authority, nor has
it established a process, of the motivations behind the chosen funding level is to levy
to verify that insurers an assessment that allows both the fraud division and county
remit all of the fraud
district attorneys to maintain their current effort in pursuing
assessments they collect
workers’ compensation fraud. However, at the December 2003
from employers.
meeting to determine the fiscal year 2004–05 aggregate fraud
assessment, one member of the fraud commission voiced her
concern that the commission was voting without enough
information to make an informed decision.
Shortcomings also exist in the process used to distribute fraud
assessment funds to county district attorneys in a way that
maximizes their effectiveness in fighting fraud. A review panel
comprising fraud commission members, representatives of
the fraud division and the Department of Industrial Relations
(Industrial Relations), and an independent criminal expert makes
recommendations to the insurance commissioner regarding
how to allocate fraud assessment funds to district attorneys
who have applied for grants. In making its recommendations,
the review panel evaluates grant applications and uses the
recommendations it receives from fraud division staff who
also conduct a review of the grant applications. However, both
the fraud division and the review panel fail to consistently
apply criteria or document the rationale they use in making
funding recommendations. Rather, each review panel member
uses a personal, subjective set of criteria when developing
recommendations for grant awards, without retaining any
evidence of the basis of any decision. Further, the panel
members do not share their decision-making criteria or rationale
with the district attorneys or with other review panel members.
Nor does the fraud division retain documentation showing
the reasoning it used to arrive at its funding recommendations
to the review panel. As a result, neither the review panel nor
22 California State Auditor Report 2002-018 California State Auditor Report 2002-018 33
the fraud division staff can provide evidence justifying their
decisions to recommend specific grant awards, leaving the
process open to the perception that it may not be equitable.
Controls intended to restrict how county district attorneys use
their grants of fraud assessment funds to pay for indirect costs are
not always effective. Department of Insurance regulations allow
county district attorneys three options for charging counties’
indirect costs to fraud assessment grants; each option is intended
to place a limit on these charges. However, one option is based
on cost rate proposals approved under requirements of the
United States Office of Management and Budget, without any
input from the fraud commission or insurance commissioner, and
does not provide the control of charges of indirect costs provided
by the other two options. As a result, one county district attorney
charges county administrative costs to the grant at a rate equal to
43 percent of the total salaries and wages charged to the grant.
Because the fraud division has not conducted adequate strategic
planning it has not met all its noninvestigative responsibilities
and spends a significant portion of its workers’ compensation
antifraud resources investigating suspected fraud referrals
that do not result in criminal prosecutions by county district
attorneys. The fraud division pays for its workers’ compensation
antifraud activities using its share of the fraud assessment
funds—averaging more than $13 million per year over the
five years ending with fiscal year 2002–03—that are levied on
California employers.
Comprehensive strategic planning would require that the fraud
division (1) take specific steps to identify all its responsibilities for
the workers’ compensation antifraud program, (2) establish and
prioritize goals and define the necessary objectives to accomplish
them, (3) establish timelines and action plans for completing
each objective and allocate the available resources based on its
priorities, and (4) define benchmarks for each activity that can
be used to evaluate performance outcomes and reset targets. The
fraud division has largely left all these tasks undone.
Lacking a sound strategic plan, the fraud division dedicates
too few of its workers’ compensation fraud resources to the
noninvestigative activities that its statutory responsibilities
demand. For example, the fraud division has put little effort into
conducting the research necessary to measure the magnitude of
the various types of workers’ compensation fraud, a yardstick
that could help the fraud division guide its antifraud approach
44 California State Auditor Report 2002-018 California State Auditor Report 2002-018 55
and measure its actions and effectiveness in reducing the fraud
problem. Further, the fraud division has not developed the
information on fraud needed to prepare reports for individuals
and entities overseeing the antifraud program, such as the
insurance commissioner, the Legislature, and the fraud
commission. However, the fraud division’s ability to successfully
identify goals and objectives is somewhat limited because, as
previously discussed, the fraud commission and the insurance
commissioner have not established a statewide strategy for the
antifraud program.
In addition, our review of workers’ compensation fraud cases in its
case management database reveals that the fraud division could
manage its investigative efforts more effectively. For example,
87 percent of the referrals of suspected workers’ compensation
fraud the division receives do not end up in the hands of
district attorneys for prosecution. Between September 2001 and
December 2003, the fraud division spent more than 16 percent
of its investigative hours on cases that it closed and did not
submit for prosecution. Moreover, based on past trends, one-third
of the hours charged to open cases as of December 2003 will
probably be spent on cases not submitted to district attorneys for
prosecution. Similarly, during the same time period, the division
closed 83 percent of the high-impact, high-priority cases referred
to it without submitting the cases to district attorneys, frequently
citing insufficient evidence as the reason.
Because the reporting requirements established by the Department
of Insurance are ambiguous, independent audit reports submitted
by county district attorneys participating in the antifraud program
do not assure the fraud division that the district attorneys use
grants of fraud assessment funds appropriately. Although an audit
unit within the Department of Insurance conducts reviews of
district attorneys’ use of workers’ compensation fraud assessment
funds that are effective and have resulted in the detection and
recovery of questionable expenditures, the audit unit’s limited
resources hinder its ability to audit all district attorneys, including
those receiving the largest grants. As a result, the fraud division
cannot verify that county district attorneys receiving grants
use the funds in accordance with state law, Department of
Insurance regulations, and the terms of the grant agreements.
The fraud division does not offer insurers an effective system for
referring suspected workers’ compensation fraud to the fraud
division. An effective fraud referral system is important to the
44 California State Auditor Report 2002-018 California State Auditor Report 2002-018 55
fraud division because its ability to investigate is dependent on
the number and quality of referrals it receives. Despite a legal
requirement to investigate suspected fraud and to report cases
that show reasonable evidence of fraud, insurers’ frequency
of reporting varies significantly. In fact, some of the larger
insurers in the workers’ compensation system reported no
suspected fraud referrals in 2001 and 2002. The chief of the
fraud division stated that past regulations poorly defined when
insurers should refer suspected fraud to the fraud division. The
Department of Insurance and the fraud division have recently
adopted emergency regulations in an attempt to better define
when reporting is required. Additionally, the fraud division
is currently working to increase and improve its monitoring
of insurers’ special investigative units, which are responsible
for reporting fraud. Included in the fraud division’s planned
improvements is developing a new method for auditing the
special investigative units.
Nonetheless, the fraud division’s efforts to ensure that it
receives referrals of suspected fraud from insurers still have
many internal weaknesses. A lack of strategic planning has left
the fraud division’s special investigative audit unit without a
program that effectively targets insurers to achieve maximum
compliance with reporting requirements, a standardized
approach to its audits that will ensure an adequate review,
timely reports and follow-up on audit findings, and effective
penalties to promote compliance.
Improving its ability to gather information from other departments
could also help the fraud division identify potential workers’
compensation fraud. Specifically, the Division of Labor Standards
Enforcement (DLSE) within Industrial Relations investigates
violations of certain labor laws, including the failure to provide
workers’ compensation insurance and benefits to employees.
However, the DLSE does not routinely refer its findings to the fraud
division for consideration of possible criminal prosecution. During
2003, the DLSE cited nearly 1,300 employers for failing to provide
workers’ compensation insurance and benefits for their employees.
Having information on some of these cases, particularly those
involving repeat offenders, might have alerted the fraud division
of noncompliance with the law and helped it detect potentially
fraudulent activities. The fraud division chief told us he has sought
to improve information sharing between the fraud division and
divisions within Industrial Relations.
66 California State Auditor Report 2002-018 California State Auditor Report 2002-018 77
Further, Industrial Relations has not implemented three
mandated programs that would enhance efforts to identify
and prevent workers’ compensation fraud. Recent legislation
required the DLSE, in conjunction with the Employment
Development Department and the Workers’ Compensation
Insurance Rating Bureau, to establish a program to identify
employers that fail to secure workers’ compensation insurance
for their employees. This requirement is similar to a pilot project
that demonstrated that such a program provides an effective and
efficient method for discovering illegally uninsured employers.
Industrial Relations’ Division of Workers’ Compensation
(DWC) is also required by recent legislation to implement a
protocol for reporting suspected medical provider fraud and
a program to annually warn employers, claims adjusters and
administrators, medical providers, and attorneys who participate
in the workers’ compensation system against committing
workers’ compensation fraud. Notification of the legal risks is
regarded as an important step in deterring fraud.
Finally, improvement is needed in the process used to collect the
fraud assessment funds that finance increased antifraud activities.
Specifically, the formulas Industrial Relations uses to calculate the
workers’ compensation fraud assessment surcharge rates have,
in recent years, consistently resulted in insured employers being
overcharged. In addition, Industrial Relations suspects that not all
insurers correctly report and remit all the workers’ compensation
fraud assessment surcharges they collect from employers.
Industrial Relations estimates that a range of roughly $8 million
to more than $13 million has been unreported and unremitted
during 1999 through 2001. However, Industrial Relations stated
it does not have the authority, nor has it established a process, to
verify that insurers remit all of the fraud assessment surcharges
collected from employers.
RECOMMENDATIONS
To better determine the assessment to levy against employers
each year for use in reducing fraud in the workers’ compensation
system, the fraud commission and the insurance commissioner
should direct the fraud division to measure the nature and
extent of fraud in the workers’ compensation system. To
establish benchmarks to gauge the effectiveness of future
antifraud activities, these measures should include analyses of
available data from insurers and state departments engaged
in employment-related activities, such as Industrial Relations
66 California State Auditor Report 2002-018 California State Auditor Report 2002-018 77
and the Employment Development Department. In addition,
the insurance commissioner should consider reactivating
an advisory committee comprising stakeholders focused
on reducing fraud in the workers’ compensation system to
contribute to the data analyses, provide input about the effects
of fraud, and suggest priorities for reducing it. This advisory
committee should meet regularly and in an open forum to
increase public awareness and the accountability of the process.
Given the nature and extent of fraud in the system, the fraud
commission and the insurance commissioner and his staff
should design and implement a strategy to reduce workers’
compensation fraud. The strategy should be systemwide in
scope and include objectives, priorities, and measurable targets
that can be effectively communicated to the fraud division
and the county district attorneys participating in the antifraud
program. Efforts to achieve the strategy targets should be both a
condition for receiving awards of fraud assessment funds and a
measure of how well the fraud division and the county district
attorneys pursue the systemwide objectives. The strategy should
clearly define the roles and responsibilities of the participants in
antifraud activities.
To gather the information it needs to determine the annual
amount to assess employers to fight fraud in the workers’
compensation system, the fraud commission should take the
following steps:
• Revamp its decision-making process so that it includes
the best information available, including (1) the results
of the Department of Insurance’s analyses of the nature and
extent of fraud in the workers’ compensation system, once
they are completed; (2) analysis of the effectiveness of efforts
by the fraud division and district attorneys in the prior year
to reduce fraud in accordance with their respective antifraud
program objectives; and (3) any newly emerging trends in
fraud schemes that should receive more attention.
• Request an annual report from the fraud division that
outlines (1) its objectives from the prior year that are linked
to measurable outcomes (2) and its objectives for the ensuing
year, together with estimates of the expenditures the fraud
division needs to make to accomplish those objectives.
• Request, in addition to the information currently required
of each county district attorney planning to participate in
the antifraud program, a report listing the district attorney’s
88 California State Auditor Report 2002-018 California State Auditor Report 2002-018 99
accomplishments in achieving the goals and objectives
outlined in the prior year’s application and the goals and
objectives for the ensuing year. The report should also include
the estimated cost of the grant year’s activities to achieve
the district attorney’s goals and objectives and a description
of how those goals and objectives align with the program
goals described by the fraud commission and the insurance
commissioner.
To better ensure that fraud assessment funds are distributed
to district attorneys so as to most effectively investigate and
prosecute workers’ compensation fraud and increase their
accountability in using the funds, the fraud commission and the
insurance commissioner should take the following steps:
• Develop and implement a process for awarding fraud
assessment grants that provides for consistency among those
making funding recommendations by incorporating standard
decision-making criteria and a rating system that supports
funding recommendations.
• Include in the decision-making criteria how well county
district attorneys’ proposals for using fraud assessment
funds align with the strategy and priorities developed by
the fraud commission and the insurance commissioner, as
well as the district attorneys’ effectiveness in meeting the
prior year’s objectives.
• Document the rationale for making decisions on
recommendations for grant awards.
• Change the past policy of awarding the base portion
of fraud assessment grants to county district attorneys
exclusively on whether they submit a completed
application by required deadlines and instead, make
recommendations for total grant awards, including the base
allocations, on evaluations of county district attorneys’
plans that include how they will use the funds, as required
by Department of Insurance regulations.
• Continue current efforts to establish performance measures
to use in evaluating the effectiveness of the fraud division
and participating district attorneys in reducing workers’
compensation fraud. The measures can also assist in determining
recommendations for grant awards to the county district
attorneys and the fraud division.
88 California State Auditor Report 2002-018 California State Auditor Report 2002-018 99
To ensure that it fulfills all aspects of its role in the workers’
compensation antifraud program, the fraud division should take
the following steps:
• Recognize its responsibilities beyond investigating fraud: (1)
conducting the research needed to advise the fraud commission
and the insurance commissioner on the optimum aggregate
assessment needed by the program annually to fight workers’
compensation fraud, (2) using documented past performance
and future projections to advise on the most effective
distribution of the funds assessed to investigate and prosecute
workers’ compensation fraud, and (3) reporting on the economic
value of insurance fraud and making recommendations to
reduce it.
• Modify its business plan to meet noninvestigative
responsibilities, including establishing appropriate goals
and objectives, activities, and priorities.
• Establish benchmarks to measure its and the district attorneys’
performance in meeting goals and objectives and to
determine whether the antifraud program is operating as
intended and resources are appropriately allocated.
• Reevaluate the process it has established for insurers and other
state entities involved in employment-related activities to
report suspected fraud. The fraud division should identify the
type of referrals and level of evidence it requires to reduce
the number of hours it spends on referrals that it ultimately
does not pass on to county district attorneys for prosecution.
To justify the use of fraud assessment funds, the fraud
commission and the insurance commissioner should require
the fraud division to conduct a return-on-investment analysis
for the workers’ compensation antifraud program as a whole
and to annually report the results to the fraud commission and
the insurance commissioner.
To improve the level of assurance contained in the independent
audit reports submitted by county district attorneys regarding
fraud assessment funds being spent for program purposes, the
fraud division should do the following:
• Clarify its expectations for the independent audits by seeking
a change in the Department of Insurance regulations that
require audit reports to provide an opinion on county
1100 California State Auditor Report 2002-018 California State Auditor Report 2002-018 1111
district attorneys’ level of compliance with key provisions
of the applicable laws, regulations, and terms of the fraud
assessment grants.
• Ensure that county district attorneys comply with the
independent audit requirements and submit their audit
reports in a timely manner.
To ensure that it receives the suspected fraud referrals it needs
from insurers to efficiently investigate suspected fraud, the fraud
division should continue its efforts to remove the barriers that
prevent insurers from providing the desired level of referrals.
Additionally, the Department of Insurance should seek the
necessary legal and regulatory changes in the fraud-reporting
process. Barriers to adequate referrals include the following:
• Lack of a uniform methodology and standards for assessing
and reporting suspected fraud.
• Regulations that poorly define when insurers should report
suspected fraud to the fraud division.
• Perceived exposure to civil actions when criminal prosecutions
of referrals are not successful.
Given the number of referrals of suspected fraud cases by insurers
that the fraud division has decided not to investigate because of
a perceived lack of sufficient evidence, the fraud division should
work with insurers to reduce the number of referrals that are
not likely to result in a successful investigation or prosecution,
thereby preserving limited resources. It should also work to
ensure that the referrals that insurers do make contain the level of
evidence necessary for the fraud division to assess the probability
of a successful investigation and prosecution.
Once the fraud division has determined the level of evidence
included with the suspected fraud referrals it needs from
insurers, it should implement a strategy for its special investigative
audit unit to focus the unit’s limited resources on determining
whether insurers are following the law in providing the referrals
the fraud division needs.
To help the fraud division investigate employers that fail to
secure payment for workers’ compensation insurance for their
employees, the DLSE should track employers that do not provide
1100 California State Auditor Report 2002-018 California State Auditor Report 2002-018 1111
workers’ compensation insurance for their employees and
report to the fraud division any employer that repeatedly fails to
provide workers’ compensation insurance.
To ensure that it effectively targets employers in industries
with the highest incidence of unlawfully uninsured employers,
the DLSE should establish a process that uses data from the
Uninsured Employers Fund, the Employment Development
Department, and the Workers’ Compensation Insurance Rating
Bureau, as required by law.
To provide a mechanism to allow reporting of suspected medical
provider fraud, the DWC should implement the fraud-reporting
protocols required by law.
To help deter workers’ compensation fraud, the DWC should
warn participants in the workers’ compensation system of the
penalties of fraud, as required by law.
To avoid overcharging the State’s insured employers for the
workers’ compensation fraud assessment, Industrial Relations
should work with the Workers’ Compensation Insurance Rating
Bureau to improve the accuracy of the projected premiums for
the current year, which it uses to calculate the fraud assessment
surcharge to be collected from insured employers.
To make certain that insurers do not withhold any portion of
the fraud assessment surcharge, Industrial Relations should seek
the authority and establish a method to verify that insurers
report and submit the fraud assessment surcharges they collect
from employers.
AGENCY COMMENTS
The insurance commissioner, Fraud Assessment Commission, and
the Labor and Workforce Development Agency generally agree
with our recommendations and each provides comments on our
findings. Our comments follow their respective responses. n
1122 California State Auditor Report 2002-018 California State Auditor Report 2002-018 1133
INTRODUCTION
BACKGROUND
The California Constitution authorizes the Legislature to
create and enforce a workers’ compensation system that
requires employers to provide benefits to workers who
suffer work-related injuries and illnesses. Injured workers are
entitled to receive all medical care that is reasonably required
to cure and relieve the effects of the disability. Additionally,
any injured worker who cannot return to work within three
days is entitled to receive disability payments to partially
replace lost wages. A worker permanently disabled or unable to
return to the same line of work due to the nature of the injury
is entitled to receive a vocational rehabilitation voucher and,
in some cases, a permanent disability benefit. In exchange for
these no-fault insurance benefits, the law designates the limited
workers’ compensation benefits as the exclusive remedy for
injured employees against their employers, even if the injury
is due to employer negligence. To secure these benefits for
injured workers, employers either make premium payments to
purchase workers’ compensation insurance or pay for benefits
directly through self-insurance.
Unlike most social insurance programs, such as Social Security or
unemployment compensation, a single government or private
agency does not administer workers’ compensation in California.
Rather, employers, insurers, claims administrators, medical service
providers, and others have roles in processing workers’ claims for
benefits within the workers’ compensation system.
The total cost of California’s workers’ compensation system has
more than doubled recently, growing from about $9.5 billion in
1995 to about $25 billion in 2002. This dramatic rise in costs has
caused sharp increases in the workers’ compensation insurance
premiums employers pay, prompting efforts to reform various
aspects of the system. Several of these reform efforts aim to
combat the amount of workers’ compensation fraud. Fraud in a
variety of forms is alleged to occur in the workers’ compensation
system, perpetrated by workers, medical and legal providers, or
employers and insurers.
1122 California State Auditor Report 2002-018 California State Auditor Report 2002-018 1133
LEGISLATION DESIGNED TO ENHANCE THE DETECTION
OF FRAUD
Three statutes enacted since 1991 were either wholly or
partially intended to enhance the State’s efforts to combat
workers’ compensation fraud. Chapter 116, Statutes of 1991
(Senate Bill 1218), contained provisions that increased the penalties
for workers’ compensation fraud and provided a means to assess
employers—through their workers’ compensation premiums or
directly if self-insured—an annual amount to be used to investigate
and prosecute fraud in the workers’ compensation system. This
legislation also established the Fraud Assessment Commission
(fraud commission), which is responsible for determining the
annual assessment (a minimum of $3 million a year) after
considering the advice and recommendations of the Department
of Insurance’s Fraud Division (fraud division) and the insurance
commissioner. The legislation provided that the fraud commission
be composed of seven members: two representing organized labor,
two representing self-insured employers, one representing insured
employers, one representing workers’ compensation insurers, and
the president of the State Compensation Insurance Fund (State
Fund) or a designee. The governor appoints all the members of
the fraud commission except the seat held by the president of the
State Fund. Finally, the legislation required that insurers or agents
authorized to act on the insurers’ behalf release evidence related to
suspected workers’ compensation fraud to specified government
agencies and to report suspected fraudulent claims.
Chapter 6, Statutes of 2002 (Assembly Bill 749), expanded the
types of antifraud activities that can be funded by the annual
fraud assessments to include investigating and prosecuting
employers that willfully fail to secure workers’ compensation
benefits for their employees. This provision is generally targeted
at employers that do not purchase workers’ compensation
insurance and self-insured employers that fail to pay benefits
to which their employees are entitled. This legislation also
required the Department of Industrial Relations’ (Industrial
Relations) labor commissioner to establish a program, in
cooperation with the Employment Development Department,
licensed rating bureaus, and other entities, to identify employers
that are unlawfully uninsured. This requirement is similar
to a pilot project coordinated by the Commission on Health
and Safety and Workers’ Compensation during the mid- to
late-1990s in which Industrial Relations was successful in
identifying uninsured employers by checking the Employment
1144 California State Auditor Report 2002-018 California State Auditor Report 2002-018 1155
Development Department’s employment records against
the insurance policy information from the databases of the
Workers’ Compensation Insurance Rating Bureau.
Chapter 639, Statutes of 2003 (Senate Bill 228), required the
administrative director of the Division of Workers’ Compensation
(DWC) within Industrial Relations to coordinate with the fraud
division, the State’s Medicaid Assistance Program (Medi-Cal)
Fraud Task Force, and the Department of Justice’s Medi-Cal fraud
bureau to adopt protocols similar to those adopted by the
fraud division for insurers, employers, claims administrators,
and others for reporting medical provider fraud within the
workers’ compensation system. The legislation directed that
the protocols accommodate the required reporting by any
insurer, self-insured employer, third-party administrator (claims
administrator), workers’ compensation administrative law
judge, audit unit, attorney, or other person who believes that
a person or entity providing medical care within the workers’
compensation system has submitted a fraudulent claim.
ENTITIES INVOLVED IN REDUCING FRAUD AND
ENFORCING COMPLIANCE WITH LAWS GOVERNING
THE WORKERS’ COMPENSATION SYSTEM
Several state and local agencies are involved in some type
of activity to reduce the amount of fraud in the workers’
compensation system and ensure that relevant laws are followed.
The Fraud Assessment Commission
To fund the current level of investigation and prosecution
of workers’ compensation fraud, the Legislature created the
fraud commission, which annually determines the aggregate
amount to assess employers to fund both the fraud division’s
activities in investigating suspected fraud and local district
attorneys’ efforts to investigate and prosecute cases involving
workers’ compensation fraud. At its annual meeting, the
fraud commission solicits input from the fraud division and
district attorneys to ascertain the extent to which workers’
compensation fraud is a problem in their respective jurisdictions
and to identify a statewide funding level adequate to fight fraud.
This aggregate assessment is collected in the form of a surcharge
levied by Industrial Relations from employers on behalf of
the fraud commission and deposited in a special workers’
compensation fraud account in the Insurance Fund. However,
1144 California State Auditor Report 2002-018 California State Auditor Report 2002-018 1155
when Industrial Relations collects more than the annual amount
authorized by the fraud commission, it places the excess
amount in its special deposit fund and uses that amount to
offset the following year’s assessment.
From the annual aggregate assessment, deductions are made
for incidental program expenses that, according to Department
of Insurance regulations, include the costs incurred by the
Department of Insurance and Industrial Relations to administer
the program and may also include fraud commission expenses,
administrative support for the fraud division’s antifraud
program, and other costs. The law then requires that, of the
remaining aggregate amount assessed annually by the fraud
commission, at least 40 percent be provided to the fraud division
for enhanced investigative efforts and at least 40 percent be
distributed to local district attorneys to investigate and prosecute
workers’ compensation fraud. The remaining 20 percent of
the aggregate assessment must be split between the fraud
division and the local district attorneys at the discretion of
the fraud commission. Correspondence we obtained from the
fraud division indicates that for the past two fiscal years, the
split has been 45 percent to the fraud division and 55 percent
to the local district attorneys. According to the law, the fraud
assessment funds can be used only for enhanced investigation
and prosecution of workers’ compensation fraud and the willful
failure to provide workers’ compensation insurance or to pay
for the benefits to which workers are legally entitled. Figure 1
shows the historical level of this fraud assessment.
The Department of Insurance’s Fraud Division
The fraud division within the Department of Insurance conducts
investigations of suspected insurance fraud and carries out
other antifraud efforts. Established in 1979, the fraud division
has grown to 208 authorized peace officer positions, 182 of
which were filled as of January 2004, and 78 non-peace officer
positions, 66 of which were filled as of January 2004. These
positions provide the investigative and support services for
the fraud division’s automobile, workers’ compensation, and
property and casualty antifraud programs. Under its workers’
compensation antifraud program, the fraud division’s role since
1991 has been primarily to receive referrals from insurers and
others in a position to detect potential workers’ compensation
fraud; investigate referrals that show merit; and, once it has
gathered sufficient evidence, refer cases to county district
attorneys for prosecution. The fraud division also performs
1166 California State Auditor Report 2002-018 California State Auditor Report 2002-018 1177
FIGURE 1
Aggregate Antifraud Assessment
Fiscal Years 1992–93 Through 2002–03
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Source: Fraud Division’s Annual Program Reports.
Note: The aggregate assessment for fiscal year 1992–93 includes a partial year’s
assessment for fiscal year 1991–92, the year the antifraud program was enacted.
*Amount includes $2.4 million in restitution funds directed to district attorneys.
outreach to the workers’ compensation community by providing
information and training on how to detect and deter fraud.
Figure 2 on the following page shows the current organization of
the fraud division.
County district attorneys receive fraud assessment funds to
investigate and prosecute workers’ compensation fraud. Through
the nine regional offices it maintains throughout the State, the
fraud division works jointly with county district attorneys to
prosecute and deter workers’ compensation fraud. Participation
by county district attorneys in the workers’ compensation
antifraud program is voluntary through a grant application
process. Figure 3 on page 19 shows the number of county district
attorneys who have participated in the workers’ compensation
antifraud program since the inception of the grant application
process in fiscal year 1991–92. As of fiscal year 2002–03, 34
county district attorneys were participating in the program.
1166 California State Auditor Report 2002-018 California State Auditor Report 2002-018 1177
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1188 California State Auditor Report 2002-018 California State Auditor Report 2002-018 1199
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FIGURE 3
Number of County District Attorneys Participating
in the Antifraud Program
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Source: Fraud Division, Department of Insurance.
The law contains specific requirements that participants in the
workers’ compensation system report suspected fraud to local
law enforcement agencies and the fraud division. For example,
the Insurance Code states that any insurer or licensed rating
organization that reasonably believes it has knowledge of
a fraudulent act involving a workers’ compensation claim or
policy shall notify the local district attorney’s office and the fraud
division. Moreover, the law requires each insurer to maintain a
special investigative unit to detect, investigate, and refer suspected
workers’ compensation fraud to the appropriate authority.
The Review Panel
Department of Insurance regulations establish a review panel
whose function is to review district attorneys’ grant applications
for fraud assessment funds and provide funding recommendations
to the insurance commissioner. The review panel comprises two
members of the fraud commission, the chief of the fraud division
1188 California State Auditor Report 2002-018 California State Auditor Report 2002-018 1199
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or a designee, the director of Industrial Relations or a designee,
and an expert in consumer crime investigation and prosecution
designated by the insurance commissioner.
After the annual aggregate assessment has been determined,
the insurance commissioner sends a request for application to
each county district attorney in the State. Each district attorney
applying for funds must submit a grant application to the fraud
division and the review panel describing his or her plans for
investigating and prosecuting workers’ compensation fraud in
that county. The review panel then evaluates each application,
using application requirements specified in Department of
Insurance regulations.
Before distributing funds to district attorneys, the insurance
commissioner must determine the most effective distribution of the
fraud assessment funds, based on the recommendation of the review
panel and with the advice and consent of the fraud division.
Under the law, the ultimate goal of the funding decisions is to
achieve the most effective distribution of the fraud assessment
funds to further the investigation and prosecution of workers’
compensation fraud cases and cases relating to employers’
willful failure to secure workers’ compensation benefits for
their employees. The insurance commissioner’s determination
of the annual funding distribution is then sent to the fraud
commission for its written advice and consent.
Other Activities Designed to Fight Workers’
Compensation Fraud
In addition to the requirements that insurers, other entities,
and individuals report suspected fraud, departments within
state government conduct other activities to detect fraud or
noncompliance with workers’ compensation law:
• The fraud division maintains a unit to audit insurers’
compliance with the requirement to investigate and report
suspected fraud.
• An audit unit in the DWC conducts reviews to measure
insurers’ compliance in providing benefits, including workers’
compensation benefits, to injured workers.
• Industrial Relations’ Division of Labor Standards Enforcement
(DLSE) conducts reviews to measure employers’ compliance
with various labor laws, including the requirement to secure
workers’ compensation benefits for their employees.
2200 California State Auditor Report 2002-018 California State Auditor Report 2002-018 2211
• The Ethics and Operational Compliance Unit, an audit unit
within the Department of Insurance, reviews some county
district attorneys’ use of their grants of workers’ compensation
fraud assessment funds.
SCOPE AND METHODOLOGY
Section 1872.83 of the Insurance Code (Chapter 6, Statutes of 2002),
requires the Bureau of State Audits (bureau) to evaluate the
effectiveness of the efforts of the fraud commission, the fraud
division, the Department of Insurance, and Industrial Relations,
as well as local law enforcement agencies, including district
attorneys, in identifying, investigating, and prosecuting workers’
compensation fraud and employers’ willful failure to secure
workers’ compensation benefits for their employees.
To understand the roles and responsibilities of the State’s
workers’ compensation antifraud efforts, we reviewed the
relevant sections of the California Labor Code and Insurance
Code, as well as the California Code of Regulations. To
comprehend the activities conducted by the state departments,
the fraud commission, and other entities involved in
antifraud efforts, we interviewed key management staff of
the Department of Insurance, Industrial Relations, members of
the fraud commission, members of the review panel, and a
representative of the California District Attorneys Association.
On April 19, 2004, the governor signed into law a bill—Senate
Bill 899—relating to workers’ compensation reform. We did not
evaluate what, if any, effect this legislation might have on the
issues discussed in this report.
To identify and understand any existing strategy to carry out
the workers’ compensation antifraud program backed by fraud
assessment funds and to identify any goals and priorities for
implementing such a strategy, we interviewed key management
staff of the Department of Insurance and the fraud division,
as well as members of the fraud commission, and reviewed
various documents and records. We also interviewed members
of the fraud commission and reviewed records of its meetings
to comprehend the process used to determine annual funding
levels for antifraud activities authorized by law and to identify
any efforts to establish that the funds are used in a manner that
will result in the most effective investigation and prosecution of
workers’ compensation fraud.
2200 California State Auditor Report 2002-018 California State Auditor Report 2002-018 2211
To comprehend and evaluate the process for determining
the distribution of fraud assessment funds to county district
attorneys who apply to participate in the workers’ compensation
antifraud program, we interviewed members of the review
panel and the fraud division and reviewed the county district
attorneys’ applications for grant funds and any available
documents used to evaluate those applications. Specifically, we
reviewed the available documentation and interviewed fraud
division staff and members of the review panel to identify any
effort to establish that the fraud assessment funds are allocated
to local district attorneys so as to most effectively investigate
and prosecute workers’ compensation fraud.
We asked key management staff from the fraud division about
their strategic planning to meet the fraud division’s
responsibilities as contained in the Insurance Code. We reviewed
the documents the fraud division made available to us to identify
management’s strategy, goals, and priorities in achieving the
purpose of the workers’ compensation antifraud program. We also
asked fraud division managers about any efforts to measure the
extent and nature of fraud in the workers’ compensation system.
To determine how effective the fraud division is in investigating
workers’ compensation fraud referrals that result in submittal to
district attorneys for prosecution and how efficiently it allocates
its investigative resources, we reviewed the referrals contained
in the fraud division’s database concerning alleged workers’
compensation fraud and the hours charged in investigating those
referrals for the period September 2001 through December 2003.
As part of this effort, we verified the reliability of the fraud
division’s database and found it sufficiently reliable for the
purposes of this audit.
We interviewed fraud division managers and reviewed
documents to assess the fraud division’s effectiveness in
reviewing and promoting insurers’ compliance with the law’s
requirement to report suspected fraud to the fraud division.
We also queried the fraud division’s database of referrals of
suspected workers’ compensation fraud to understand insurers’
compliance with the requirement to report suspected fraud, and
we interviewed the manager of the special investigative unit at
the State Fund to gain her perspective on the issues surrounding
compliance with the requirement.
2222 California State Auditor Report 2002-018 California State Auditor Report 2002-018 2233
To identify the extent to which other state departments
cooperate with the fraud division in sharing information about
the actual or potential occurrence of fraud in the workers’
compensation system, we interviewed key management staff
from the DWC and the DLSE and reviewed documents to
determine their level of activity to enforce labor laws, the
likelihood that their activities will uncover actual or potential
fraud, and the extent to which these two divisions report actual
or suspected workers’ compensation fraud to the fraud division
or a district attorney.
We reviewed Industrial Relations’ process for collecting the
assessment authorized by the fraud commission to determine
whether it followed the requirements of the law and its
regulations, and we examined whether the funds are transferred
to the Department of Insurance for use in antifraud efforts as
authorized by the law.
To determine the effectiveness of the fraud division’s efforts to
establish accountability for the district attorneys’ use of
workers’ compensation fraud assessment funds, we asked the
fraud division about its efforts to monitor the district attorneys’
spending of the fraud assessment funds. We also interviewed
the chief of the Ethics and Operational Compliance Office
within the Department of Insurance and reviewed his work
papers and audits of county district attorneys’ use of workers’
compensation fraud assessment funds, and we reviewed
audit reports of district attorneys’ expenditures conducted by
independent auditors.
Finally, to understand the fraud division’s accountability over
its use of fraud assessment funds, we reviewed its procedures
to ensure that those funds are used exclusively for workers’
compensation antifraud efforts. n
2222 California State Auditor Report 2002-018 California State Auditor Report 2002-018 2233
Blank page inserted for reproduction purposes only.
2244 California State Auditor Report 2002-018 California State Auditor Report 2002-018 2255
CHAPTER 1
Workers’ Compensation Antifraud
Efforts Lack Adequate Planning
and Coordination, and Funding Is
Not Determined Using Established
Priorities
CHAPTER SUMMARY
The Fraud Assessment Commission (fraud commission)
and the insurance commissioner have not developed
a statewide vision and plan for fighting fraud in the
workers’ compensation system; therefore, neither can be
certain that the antifraud assessment levied against California
employers is being used to most effectively investigate,
prosecute, and reduce fraud in the workers’ compensation
system. Antifraud efforts also lack an underlying strategy
for estimating the amount of fraud in the system and for
developing a statewide plan that prioritizes the actions needed
to combat it, including a way to measure the plan’s success in
reducing fraud in the workers’ compensation system. As a result,
the fraud commission does not have adequate information on
which to base its annual assessment, nor does it have the means
to allocate the assessment in a manner that ensures that fraud is,
in fact, reduced.
Because the fraud commission and the insurance commissioner
have not identified the magnitude and nature of fraud in the
workers’ compensation system, they have not formulated or
communicated objectives and measurable targets for reducing
fraud to the entities responsible for investigating and prosecuting
it. Consequently, they cannot be certain that the assessment
levied on California’s employers is at the appropriate level to
control fraud, and they have no way to demonstrate that their
efforts are having the desired effect of reducing the costs that
fraud adds to the workers’ compensation system. Additionally,
uncertainty about the types of fraud being perpetrated and
their magnitude severely hinders the ability of both the fraud
commission and the insurance commissioner to identify
priorities and assign to district attorneys and the Department of
Insurance’s Fraud Division (fraud division) the proper roles and
responsibilities in identifying and fighting fraud.
2244 California State Auditor Report 2002-018 California State Auditor Report 2002-018 2255
Moreover, with no way to measure the success of their efforts,
the fraud commission and the insurance commissioner cannot
be certain that they are distributing fraud assessment funds
to state and local entities to most effectively investigate and
prosecute workers’ compensation fraud. For example, rather
than being based on performance measures, decisions regarding
the distribution of fraud assessment funds are based on historical
funding levels and a subjective review of funding requests.
THE FRAUD COMMISSION AND THE INSURANCE
COMMISSIONER CANNOT BE CERTAIN THAT FRAUD
ASSESSMENT FUNDS ARE EFFECTIVELY USED TO
REDUCE FRAUD
The assessments levied on employers to fund the antifraud
program have increased dramatically since the program’s inception.
Although the aggregate In fiscal year 1992–93, the aggregate assessment was $10 million; by
assessment has grown fiscal year 2004–05, it had grown to more than $34 million.
from $10 million in However, neither the fraud commission nor the insurance
fiscal year 1992–93 to commissioner has taken adequate steps to ensure that the antifraud
$34 million by fiscal year assessment is necessary or is used to maximize the reductions in
2004–05, neither the the costs that fraud adds to the workers’ compensation system.
fraud commission nor the
insurance commissioner For example, no meaningful effort has been made to measure
has taken adequate the extent and nature of fraud in the workers’ compensation
steps to ensure that system or to develop a baseline against which to measure
the assessed amount is the effectiveness of future antifraud efforts. In addition, the
necessary or put to the program lacks an overall strategy for using the funds to reduce
best use for reducing fraud most effectively and efficiently—a strategy that could be
the costs that fraud translated into objectives, priorities, and measurable targets to
adds to the workers’ guide state and local entities involved in fraud reduction efforts.
compensation system. The measured level of fraud and the strategy for combating
it could be used as criteria for determining the appropriate
assessment to levy against employers each year and for
allocating those funds to state and local entities that participate
in the antifraud effort. Instead, the fraud assessment funds are
used each year to finance the independent efforts of the district
attorneys, with each attorney pursuing individual objectives
and priorities for a particular county’s antifraud program.
Without a systematic effort to measure the extent of fraud in
the workers’ compensation system, determine the types of fraud
most responsible for driving up insurance premium rates, create
an overall strategy to combat fraud, and establish a process to
periodically evaluate the effectiveness of antifraud efforts (at
both the state and local level), neither the fraud commission nor
2266 California State Auditor Report 2002-018 California State Auditor Report 2002-018 2277
the insurance commissioner can assure California’s employers
that their fraud assessments are being well spent. Simply put,
the fraud commissioner and the insurance commissioner cannot
justify the annual antifraud assessment.
An August 2001 report by the Commission on Health and
Safety and Workers’ Compensation identifi es six major
questions regarding workers’ compensation fraud that need
to be answered to develop an effective and effi cient strategy
(see the text box). Although the fraud commission, with the
advice and recommendations of the insurance commissioner,
assessed employers $34 million for fi scal year 2004–05 to pay for
antifraud activities, some of these questions remain
substantially unanswered or unresolved.
Questions for Developing a Strategy
to Combat Fraud in the Workers’
The Extent and Nature of Fraud Within
Compensation System
the Workers’ Compensation System Is Not
• Is workers’ compensation fraud a Adequately Measured or Monitored
major problem?
Neither the fraud commission nor the insurance
• What should be the scope of the
commissioner has made a meaningful attempt to
antifraud campaign?
measure how much and what types of fraud exist
• What should be the focus and priority of
antifraud efforts? in the workers’ compensation system. When we
asked the assistant chief deputy commissioner if
• What should be the source and level of
funding for antifraud efforts? the Department of Insurance had attempted such a
• Should there be a greater interagency measurement, she responded that the department
coordination of antifraud efforts? has drawn on the research of others, such as the
• Are there any new ideas or innovative studies cited in a draft issue paper prepared by
approaches that might improve the
the fraud division. However, the draft issue paper
antifraud program?
does not mention a methodology for measuring
fraud. In fact, although the fraud division’s issue
Source: Commission on Health and Safety and
paper is in the draft stage and does not present
Workers’ Compensation.
any conclusions on the merits of attempting
to measure fraud in the workers’ compensation
system, it does contain several statements and
quotes indicating the diffi culty, the inconsistency, and even the
futility of efforts to measure fraud.
Professionals who study fraud maintain that a systematic
measurement of fraud is paramount to identifying the
appropriate approach to controlling a fraud problem. In an issue
paper on measuring fraud, the Coalition Against Insurance Fraud
(coalition), an industry group primarily comprising entities
associated with insurer and consumer groups, states that the
most common rationale given for measuring fraud is a simple
one: You need to know the extent of the problem to effectively
2266 California State Auditor Report 2002-018 California State Auditor Report 2002-018 2277
solve it. In his 2000 book License to Steal: How Fraud Bleeds
Professionals who study America’s Health Care System, Malcolm Sparrow states that basic
fraud maintain that a decision theory teaches the value of information when choosing
systematic measurement between alternative courses of action. He further states that
of fraud is paramount without knowing the true level of fraud, policymakers will likely
to identifying the make enormously costly errors by over- or underinvesting to
appropriate approach to control fraud. The coalition further points out that a secondary
controlling fraud. Neither rationale for consistent measurement is to gain credibility
the fraud commission through convincing consumers and legislators that fraud is a
nor the insurance problem that requires remedies.
commissioner has made
a meaningful attempt In the absence of systematic measurement, fraud can only be
to measure how much estimated, and some estimates can reflect the interests of the
and what types of fraud entities that provide the estimates. For example, in its draft issue
exist in the workers’ paper, the fraud division points out that estimates of fraudulent
compensation system. workers’ compensation claims range from 0.3 percent, as
estimated by labor unions whose members receive benefits, to
20 percent, as estimated by employers that pay for the benefits.
Clearly, there are substantial difficulties in effectively measuring
workers’ compensation fraud. The coalition points out that in
addition to the hidden nature of the crime, a major obstacle to
measuring fraud is that it means different things to different people
and that in a strict legal sense, fraud exists only when it has been
so deemed by a court ruling. For example, no universally accepted
distinction exists between abusing the workers’ compensation
system by exploiting lax rules or regulations and intentionally
defrauding the system by wrongfully gaining or denying benefits.
In addition, because workers’ compensation benefits are paid by
multiple payers, such as insurers and claims administrators, and
neither currently reports on these transactions, there is no central
claims payment database to aid in detecting systemwide fraud, as
is found in a single-payer health care system such as California’s
Medicaid Assistance Program (Medi-Cal).
Other Entities Have Devised Ways to Measure Fraud and
Noncompliance
Although determining the precise extent of fraud in the State’s
workers’ compensation system may be impossible, two federal
entities that sample available data have used certain mechanisms
to successfully measure known fraud, benchmark the problem,
and then monitor the results of fraud reduction activities. For
example, the Internal Revenue Service (IRS), in a challenge similar
to the one the fraud division faces with workers’ compensation
insurance, cannot know the exact extent of noncompliance or
2288 California State Auditor Report 2002-018 California State Auditor Report 2002-018 2299
fraud in the income tax collection system. However, the IRS has
used audits of statistically selected tax returns to gain insight
about the level of taxpayers’ overall compliance
with tax laws; understand the effectiveness of its
Tools the Internal Revenue Service regulations and programs; and design a strategy for
Plans to Use to Gain Information on enforcement audits that targets the returns most
Noncompliance and Fraud likely to be noncompliant, thereby putting the IRS’s
limited resources to their best use (see the text box).
• A representative sample of tax returns
from the target year.
Because the IRS performed its last compliance
• A specially trained cadre of examiners.
review of taxpayers using returns fi led for 1988, in
• An assortment of case-building tools
designed to verify as many reported items 2002 it was planning to review another sampling of
as possible without contacting taxpayers. returns to evaluate taxpayers’ current compliance
• A process for determining the level of with tax laws and regulations. In a June 2002
audit, if any, a taxpayer return warrants
report on the plans of the IRS to conduct its new
and which items must be verifi ed.
review, the United States General Accounting Offi ce
• An examination process that uses structured
(GAO) indicated that the IRS set a strategic goal of
procedures and managerial reviews.
ensuring taxpayer compliance but that it lacked
current measures of voluntary compliance. The
GAO advised that having such measures would help
the IRS determine current compliance levels and identify steps
likely to lead to improved compliance.
Likewise, Medicare fraud experts cite a review of medical
payment transactions as an effective tool in identifying the
extent and nature of fraud. In a September 2000 report to
Congress on improper payments in the Medicare system, the
GAO recognizes that given the sophisticated and dynamic
nature of health care, fraud detection is not an exact science. No
matter how sophisticated the fraud detection techniques used, it
is unrealistic to expect to identify all fraud. However, according
to the GAO report, the federal Centers for Medicare and
Medicaid Services (CMS), formerly the Health Care Financing
Administration, used a variety of processes to measure improper
payments. At the time of the report, the method the CMS used
to identify improper payments focused on estimating Medicare
payments that did not comply with the payment policies spelled
out by laws and regulations but did not specifi cally attempt to
identify potential fraud and abuse. The CMS was then working
to improve its methodology to provide, in part, an average
percentage of claims that were incorrectly paid or incorrectly
denied. The ultimate goal of the improvements was a national
improper-payment rate that the CMS planned to use to identify
various “hot spots” of potential fraud throughout the country,
increasing the CMS’s ability to more effectively focus its program
integrity efforts.
2288 California State Auditor Report 2002-018 California State Auditor Report 2002-018 2299
The Fraud Division Has Access to Data That Could Help It
Assess the Extent of Workers’ Compensation Fraud
According to the fraud division, although earlier antifraud efforts
in California concentrated on fraud committed by workers, the
fraud division and the insurance commissioner believe fraud
committed by medical care providers and employers is more
costly to the workers’ compensation system and thus have
assigned these types of fraud a higher priority in antifraud
efforts. However, without a systematic measurement of the types
of fraud and their magnitude, it is difficult to justify not only
current activities but also any shift in focus. According to the
fraud division chief, a lack of resources and expertise prevent
the fraud division from measuring the extent and nature of
fraud in the workers’ compensation system and determining the
effectiveness of its activities to deter fraud. However, he agrees
that, with help, the fraud division could perform such analyses.
The Department of Insurance further told us that without
detailed data on workers’ compensation transactions, such as
those that it expects may eventually be accumulated in the
Workers’ Compensation Information System of the Department
of Industrial Relations (Industrial Relations), it is difficult to
systematically identify payments that do not fit with normal
payment patterns and that may signal potential fraud.
However, the Department of Insurance already has sources
available to better detect and measure various types of fraud. For
The fraud division could example, as part of the department that regulates the insurance
perform a statistically industry, the fraud division has access to the payment databases of
valid analysis to detect all companies licensed to sell insurance in California. According
potential provider and to the coalition, the data on closed workers’ compensation claims
claimant fraud in the form in these databases include information useful in measuring fraud.
of indicators of actual or Reports by the National Association of Insurance Commissioners
potential fraud for a large for 2002 show that 37 insurers accounted for more than 84 percent
percentage of the State’s of the California workers’ compensation insurance market. As a
workers’ compensation result, using the data from as few as 37 insurers, the fraud division
insurance market using could perform a statistically valid analysis to detect potential
the data from as few as provider and claimant fraud for a large percentage of the State’s
37 insurers. workers’ compensation insurance market. The analysis could be in
the form of indicators of actual or potential fraud, as described
in the fraud division’s guidelines and protocols for identifying and
reporting potential fraud.
In addition, Industrial Relations conducts reviews of insurers,
employers, and claims administrators to determine whether injured
workers have received the benefits to which they are entitled.
3300 California State Auditor Report 2002-018 California State Auditor Report 2002-018 3311
Industrial Relations’ Division of Labor Standards Enforcement (DLSE)
reviews employers for compliance with the requirement to secure
workers’ compensation benefits for employees through its field
visits to employers in industries with a history of noncompliance.
Further, a program that the DLSE was to have implemented
by January 1, 2003, but has not yet even been developed,
would use data from the Employment Development Department
and the Workers’ Compensation Insurance Rating Bureau to
identify employers that are unlawfully uninsured for workers’
compensation benefits. All these activities could generate data that
could be used to measure the extent of workers’ compensation
fraud and serve as a baseline against which to assess the
effectiveness of subsequent efforts to reduce fraud. However, the
fraud division has no plans to use these data to measure the nature
and extent of fraud in the workers’ compensation system.
No Overall Strategy Exists to Direct Statewide Workers’
Compensation Antifraud Efforts
The fraud commission and the insurance commissioner have not
collaborated to develop a statewide strategy for reducing fraud
in the workers’ compensation system. In fact, without knowing
the extent of the problem that fraud represents to the workers’
compensation system, it would be difficult to develop a strategy that
is efficient and effective in identifying program participants’ roles
and responsibilities in managing statewide efforts to reduce fraud.
Strategic management is a process whereby managers establish
a long-term direction, set specific performance objectives,
develop strategies for achieving those objectives, and execute
Invoking an effective chosen action plans. An expert on fraud and fraud control at
antifraud model would Harvard’s John F. Kennedy School of Government has identified
require that the fraud a fraud control model that includes the following characteristics:
commission and the (1) commitment to routine, systematic measurement; (2) resource
insurance commissioner allocation for controls based on an assessment of the seriousness
design a strategy that of the problem; (3) clear designation of responsibility for fraud
addresses the necessary control; (4) deliberate focus on early detection of new types
components and ensures of fraud; and (5) fraud-specific controls that intervene before
that fraud assessment payments are made. Invoking such an antifraud model would
funds are distributed to require the fraud commission and the insurance commissioner
entities willing to carry to design a strategy that addresses most of these components and
out a statewide strategy. ensures that fraud assessment funds are distributed to entities
willing to carry out a statewide strategy.
We asked the assistant chief deputy commissioner responsible
for overseeing the Department of Insurance’s antifraud programs
about the insurance commissioner’s efforts to work with the fraud
3300 California State Auditor Report 2002-018 California State Auditor Report 2002-018 3311
commission to establish a common strategy for fighting fraud
within the workers’ compensation system. She responded that
the insurance commissioner views the program funded by the
assessments levied on employers as one program that should have
a common focus, as opposed to the many programs operated by
the county district attorneys receiving fraud assessment funds,
each with its own individual strategy and priorities. She stated
that the insurance commissioner has communicated his priorities
and strategies for antifraud efforts in the workers’ compensation
system through presentations made in public hearings conducted
by the fraud commission and that these presentations appear
in the hearing minutes. Although we found mention of
broad priorities for the antifraud program in the insurance
commissioner’s numerous presentations to the fraud commission
and legislative committees, and in press releases made throughout
2003, none of these presentations detailed his priorities for the
use of fraud assessment funds.
We also asked the assistant chief deputy commissioner how
the insurance commissioner determines his priorities for the
efforts to reduce workers’ compensation fraud that are funded
The insurance by the assessments. She stated that the insurance commissioner
commissioner’s priorities regularly meets with stakeholder groups to discuss workers’
for the fraud program are compensation issues. Priorities are influenced by stakeholders’
influenced by stakeholder input and are established with the intent of dedicating resources
input and are established to high-impact cases, such as medical mills in which workers
with the intent of with real or feigned injuries are steered to specific medical
dedicating resources to providers who give them high-cost, long-term treatments.
high-impact cases, because These high-impact cases typically result in higher amounts of
these cases typically result fraudulent activity, affect more people, and serve as a larger
in higher amounts of deterrent to future fraud when successfully prosecuted.
fraudulent activity, affect
more people, and serve The current workers’ compensation antifraud program has several
as a larger deterrent participating groups, each with an important role to play in
to future fraud when antifraud efforts. Figure 4 shows the current process of investigating
successfully prosecuted. and prosecuting fraud cases. However, as we discuss in Chapter 2,
between September 2001 and December 2003, the fraud division
did not submit 87 percent of the referrals it received to district
attorneys for prosecution. In addition, half the fraud referrals it did
submit for prosecution were for types of fraud that are not a high
priority of the insurance commissioner. Moreover, county district
attorneys do not necessarily follow the insurance commissioner’s
priorities when prosecuting workers’ compensation fraud cases. For
example, Los Angeles County received roughly 23 percent of the
total annual assessment funds distributed to district attorneys in
fiscal year 2002–03 but reported that 79 percent of its prosecutions
in that same fiscal year were for claimant fraud, despite the
3322 California State Auditor Report 2002-018 California State Auditor Report 2002-018 3333
FIGURE 4
Fraud Division’s Basic Steps in the Investigation Process
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Source: Fraud Division, Department of Insurance.
fact that the insurance commissioner has stated that fraud
by medical providers and employers is more costly to the
workers’ compensation system and thus a higher priority. For
3322 California State Auditor Report 2002-018 California State Auditor Report 2002-018 3333
fiscal years 2001–02 and 2002–03, claimant fraud accounted
for 75 percent and 65 percent, respectively, of the prosecutorial
activities of the county district attorneys that received fraud
assessment funds in those fiscal years.
An important element of an antifraud program funded through
assessments on employers is strategic planning that includes
establishing systemwide goals, objectives, and priorities that are
communicated to the participants in the program. Systemwide
goals, objectives, and priorities can be broken down into
regional elements to accommodate any unique regional fraud
problems, but they must be attainable and measurable. In the
case of the workers’ compensation antifraud program, a stated
objective of the fraud division to reduce costs by increasing
investigations of high-impact cases by 10 percent or by
increasing the number of fraud referrals by 10 percent could not
be attained with certainty because the total extent of the fraud
problem has not been measured. However, once fraud baselines
are established using the techniques previously discussed, it
would be possible to measure whether antifraud activities were
effective in attaining such an objective.
Similarly, the fraud division’s practice of measuring the success
of the antifraud program by collecting and publishing discrete
The fraud division’s statistics of investigations, arrests, convictions, and restitution
practice of collecting and shows only that some source of fraud may have been removed
publishing discrete statistics from the system. The statistics do not reveal whether antifraud
of investigations, arrests, efforts have actually reduced the overall cost that fraud adds to
convictions, and restitution the system. Nor does reporting the numbers of investigations and
as measures of success prosecutions reveal whether participants are focusing on antifraud
of the program’s efforts priorities, because different types of cases require varying
show only that some amounts of resources to investigate and prosecute, as do similar
source of fraud may have types of cases with different levels of complexity. Once baselines
been removed from the of the occurrence of fraud or potential fraud are established,
system, but does not reveal however, the level of effort being exerted on high-priority types
whether antifraud efforts of fraud and their effects on reducing fraud can be measured. For
have actually reduced the example, the baselines—combined with subsequent periodic,
overall cost that fraud systematic measurement of fraud using available data—would
adds to the system. help determine the effectiveness of programwide objectives in
reducing fraud in the workers’ compensation system. Moreover,
programwide goals and targeted levels of effort that are successful
in achieving those goals can serve as criteria for allocating
assessment funds to program participants.
We asked the chief of the fraud division if the fraud commission
and the insurance commissioner had the authority to set
statewide initiatives and priorities to be used as funding criteria
3344 California State Auditor Report 2002-018 California State Auditor Report 2002-018 3355
for the workers’ compensation antifraud program. The chief told
us that the fraud commission influences the scope and priorities
of the program through the concerns voiced at its annual
assessment meetings that the fraud division and participating
district attorneys listen and respond to. However, the chief stated
that the fraud commission is not the only entity that influences
the antifraud program; the insurance commissioner and his staff
are very involved with the program as well. Therefore, according
to the chief, any programwide initiatives and priorities that might
be used as criteria for awarding fraud assessment grants to county
The fraud commission district attorneys would need to be shared by the insurance
and the insurance commissioner and the fraud commission. To demonstrate why
commissioner have thus such a shared view is necessary, the chief gave us the example of
far not collaborated in the fraud commission’s consistent use of the arrest and conviction
developing a statewide statistics the district attorneys present in their annual reports as
strategy in the form of measures of performance and a basis for awarding funding. The
a plan containing their chief stated that, as a result, district attorneys may be influenced
consensus of the goals, to increase their arrest and conviction numbers and may not be
objectives, actions, and as willing to work on medical provider cases that can take more
performance targets time and resources but are one of the insurance commissioner’s
necessary to reduce goals. Nevertheless, the fraud commission and the insurance
fraud in the workers’ commissioner have thus far not collaborated in developing a
compensation system. statewide strategy in the form of a plan containing their consensus
of the goals, objectives, actions, and performance targets necessary
to reduce fraud in the workers’ compensation system.
The Fraud Commission and the Insurance Commissioner
Conduct Activities to Obtain Input From the Workers’
Compensation Community
On several occasions, the fraud commission and the insurance
commissioner, sometimes working with the fraud division, have
held forums that allowed for stakeholder input on fraud in the
workers’ compensation system. For example, the fraud commission
annually holds a public meeting before it determines the aggregate
assessment level. The meeting gives district attorneys participating
in the program an opportunity to describe their antifraud efforts, and
the fraud commission opens the floor to other stakeholders wishing
to make a statement before the aggregate assessment is determined.
For example, in the meeting held in December 2003, both the
insurance commissioner and a former fraud division chief spoke to
the fraud commission about the ongoing need for the antifraud effort.
In November 2003, the California District Attorneys Association and
the Department of Insurance held a roundtable discussion at which
they met with members of the fraud commission to inform and
educate them on issues related to workers’ compensation fraud.
3344 California State Auditor Report 2002-018 California State Auditor Report 2002-018 3355
The agenda for the November 2003 roundtable discussion,
which the fraud division provided us, was limited to background
discussions of the workers’ compensation antifraud program and
the funding process, upcoming legislative issues, and referrals of
suspected fraud; topics on the agenda did not include the extent
of fraud in the system or a systemwide strategy to combat it. In
addition, the fraud division had no record of any conclusions or
recommendations reached as a result of the session. According
to the manager of the fraud division’s local assistance unit, no
minutes were kept of the session and no formal action resulted.
Furthermore, the manager of the local assistance unit told us
that before this meeting, the last roundtable discussion held was
in 1999.
The workers’ compensation antifraud program could benefi t
from a committee similar to one that provides advice to the
fraud division, and to other public and private entities, on ways
to coordinate the investigation, prosecution, and prevention of
automobile insurance fraud. Established by the Insurance Code,
the committee comprises representatives from several stakeholder
groups, with the following explicit purpose and goals:
• Recommend to the fraud division and other
public and private sector agencies ways to
Entities Represented on the
coordinate the investigation, prosecution, and
Auto Fraud Advisory Committee
prevention of automobile insurance claims fraud.
• Fraud division
• Department of Justice • Assist the fraud division in implementing the
goal of reducing the frequency and severity
• Department of Motor Vehicles
of fraudulent automobile insurance claims by
• Division of Investigation of the Department
of Consumer Affairs specifi c percentages in urban and rural areas
within two years.
• California Highway Patrol
• Bureau of Automotive Repair
• Ensure that the prevention, investigation,
• Parole and Community Services Division of prosecution, and data collection efforts of the
the Department of Corrections
fraud division are effi cient, cost-effective, and
• State Bar of California
in line with similar efforts undertaken by law
• Medical Board of California enforcement agencies and insurers.
• Local law enforcement agencies
• Insurers • Make recommendations to be included in the
fraud division’s annual report.
• Labor organizations with members in the
automotive repair business
• Board of Chiropractic Examiners A workers’ compensation fraud advisory committee
with broad membership and a purpose and
goals similar to those just listed would increase
3366 California State Auditor Report 2002-018 California State Auditor Report 2002-018 3377
the ability of the fraud commission and the insurance
commissioner to ensure that statewide antifraud efforts are
efficient and cost-effective.
The assistant chief deputy commissioner stated that such an
advisory committee does exist—the Workers’ Compensation
The Workers’ Fraud Advisory Committee (fraud advisory committee). Although
Compensation Fraud the composition of the fraud advisory committee is not mandated
Advisory Committee has by statute or regulation, it typically has comprised stakeholders
not met since October 2002 in the workers’ compensation system, including representatives
because of low attendance from the insurance industry, prosecutors, investigators, and the
at committee hearings, Department of Insurance. However, the fraud advisory committee
budget limitations, and has not met since October 2002 because of low attendance
management changes at committee hearings, budget limitations, and management
at the Department transitions at the Department of Insurance. The chief of the fraud
of Insurance. division stated that he intends to reestablish the fraud advisory
committee with a broader representation of stakeholders. He
also stated that the prelude to the first meeting of the reformed
committee will be the roundtable discussions with the fraud
commission, the California District Attorneys Association, and
the Department of Insurance scheduled for later this year.
Once elected, the insurance commissioner did assemble one
advisory panel and one task force on a temporary basis to provide
input on the status of various issues surrounding the workers’
compensation system, including fraud. However, the advisory
panel’s report to the insurance commissioner, issued in
February 2003, did not address fraud. In contrast, the workers’
compensation task force (task force), in its February 2003 report
to the insurance commissioner, advised that legislation that
took effect in 2003 (Chapter 6, Statutes of 2002) amended the
Insurance Code to allow fraud assessment funds to be used to
investigate and prosecute unlawfully uninsured employers. The
task force report also warned that the rising costs in the workers’
compensation system, combined with the worsening economy,
provided an increased risk of fraud being perpetrated by
employees and employers. It recommended that the insurance
commissioner remind insurers of their responsibility to maintain
a special investigative unit and to refer all valid cases involving
alleged fraud, including those of fraudulent denial of workers’
compensation benefits, to the appropriate authority. The task
force also recommended that the insurance commissioner, in
concert with Industrial Relations and district attorneys, establish
a task force to analyze the economic and technical feasibility
of developing a statewide database of workers’ compensation
medical provider billing data that could be used to enhance
3366 California State Auditor Report 2002-018 California State Auditor Report 2002-018 3377
fraud detection and injury prevention. Finally, the task force
In his February 2004 plan recommended that the Department of Insurance conduct
for workers’ compensation outreach to the workers’ compensation community to inform
reform, the insurance them that fraud of any kind in the workers’ compensation
commissioner stated system will not be tolerated and should be mitigated through
that the Department of early proactive management.
Insurance was restructuring
its fraud and investigative In response to this and other input, the insurance commissioner,
units to improve in his February 2004 plan for workers’ compensation reform,
coordination efforts stated that the Department of Insurance is restructuring its fraud
and prioritize workers’ and investigative units to improve coordination efforts and
compensation cases. prioritize cases of fraud in the workers’ compensation system.
The insurance commissioner also said that the department is
improving its working relationship with district attorneys and
other state, federal, and local law enforcement agencies, with an
emphasis on information sharing.
ANNUAL FUNDING LEVELS FOR ANTIFRAUD EFFORTS
ARE NOT BASED ON DOCUMENTED NEEDS
The fraud commission is statutorily empowered to identify
problems associated with efforts to combat workers’
compensation fraud and provide funding to enable the fraud
division and county district attorneys to most effectively fight
that fraud. However, the fraud commission reaches its funding
decisions without adequate knowledge of the extent and nature
of the problems caused by fraud in the workers’ compensation
system or the effects of prior years’ efforts to reduce fraud. In
addition, the fraud commission lacks detailed information
regarding the plans of the fraud division and county district
attorneys for using the funds in the upcoming year to reduce
fraud in the workers’ compensation system. In fact, at the fraud
commission’s December 2003 meeting, one member voiced
her concern that the commission was voting on the fraud
assessment for fiscal year 2004–05 without having enough
information to make an informed decision.
Without the necessary information, the fraud commission
cannot ensure that the aggregate assessment it authorizes each
year is needed or is adequate to sufficiently address reducing
fraud in the workers’ compensation system. Further, there is
little assurance that the funds it assesses against California’s
employers—averaging approximately $30 million for each of the
past five years—have been used effectively to reduce the amount
of fraud and thereby reduce the overall cost that fraud adds to
the workers’ compensation system.
3388 California State Auditor Report 2002-018 California State Auditor Report 2002-018 3399
The Fraud Assessment Commission Bases the Annual Assessment
on Previous Funding Levels to Ensure Continuity of the Program
Without any meaningful measurement of the extent to which
fraud drives up workers’ compensation system costs, and
without the ability to evaluate past efforts to deter fraud, the
fraud commission bases the annual aggregate assessment on
prior years’ assessments. According to one member of the
fraud commission, one of the motivations behind the funding
decision is to levy an assessment that allows both the fraud
division and the county district attorneys to maintain their
current level of effort in pursuing workers’ compensation fraud.
As shown in Figure 5, consistent with this explanation, the
aggregate assessment has been relatively constant for the past
five years, ending with fiscal year 2002–03.
FIGURE 5
Annual Aggregate Assessment Amount Levied
by the Fraud Commission
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Source: Fraud division’s Annual Program Reports.
*Amount includes $2.4 million in restitution funds directed to district attorneys.
As shown in Figure 6 on the following page, antifraud activities
funded by fraud assessments generally resulted in increased
numbers of arrests and convictions for the first six years of
the program. However, despite relatively stable assessments
over the past five years, arrests and convictions have declined
in two of the past three years. Although these numbers do
not tell the whole story because certain types of fraud cases
3388 California State Auditor Report 2002-018 California State Auditor Report 2002-018 3399
�����������������
FIGURE 6
Number of Arrests and Convictions in the
Workers’ Compensation Fraud Program
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Source: Fraud division’s Annual Program Reports.
take longer to investigate and prosecute, without basing the
aggregate assessment on a baseline measurement of the amount
of fraud in the system and the level of funding necessary to
fight it effectively, the fraud commission and the insurance
commissioner have no way of demonstrating that the program
is cost-effective and is lowering the overall cost of fraud to the
workers’ compensation system.
The Fraud Assessment Commission Has Limited Information
When Determining the Annual Aggregate Assessment
Because the assessment is not based on the extent of fraud in
the system, the process adopted by the fraud commission to
arrive at the total funding needed to fight fraud is flawed. The
fraud commission determines the aggregate assessment without
reviewing any detailed information about the district attorneys’
past performance in reducing fraud and without obtaining a
proposal from the fraud division specifying how it plans to
spend the grant award during the coming year.
The fraud commission convenes a meeting each December
to discuss the amount it will assess California’s employers to
fund the investigation and prosecution of fraud in the workers’
4400 California State Auditor Report 2002-018 California State Auditor Report 2002-018 4411
�����������������������������
compensation system. According to the fraud division’s local
The fraud commission assistance manager, the fraud commission holds this meeting
determines the in mid-December so the assessment can be incorporated into
aggregate assessment the governor’s budget. One member of the fraud commission
amount without stated that because of the timing of this meeting, the fraud
reviewing any detailed commission has limited information on which to base its
information about the decision. Both the fraud division and the fraud commission
district attorneys’ past indicated that the primary source of data used by the fraud
performance in reducing commission in making its decision is a preliminary budget
fraud and without report supplied by each district attorney. Each county
obtaining a specific district attorney interested in participating in the workers’
proposal from the fraud compensation antifraud program is asked to submit a projected
division as to how it budget in December for review by the fraud commission. The
plans to spend the fraud division collects these budgets and provides them, along
grant award during with a summary estimate of the total amount of funding
the upcoming year. requested by district attorneys in their respective budgets, to the
fraud commission.
The fraud division asks that these budgets include a summary
of personnel services costs, operating expenses, and equipment
as well as an outline of the activities to be undertaken by the
district attorney, such as the number of projected investigations,
prosecutions, and type of caseload. For example, the overview
of one budget included a request for additional trial support
staff and a full-time legal position to investigate and prosecute
employers that fail to secure workers’ compensation benefits
for their employees, and it mentioned that several such cases
were being prosecuted. This budget also described some of the
outreach projects carried out in the past year and the district
attorney’s desire to continue those types of activities. However,
other than anecdotally discussing the cases the district attorney
anticipated would be concluded, the budget did not cover the
number of cases the district attorney planned to prosecute or
how many and what types of outreach projects would take place
over the next year. Without this type of detailed information,
the fraud commission has a limited ability to ascertain the true
resource needs of each county district attorney in fighting fraud.
Although the fraud commission does receive the district
attorneys’ budgets before it holds its hearing to decide on
the annual fraud assessment, the district attorneys’ reports
outlining the activities they completed with the prior year’s
funding are not required until January, nearly one month
after the fraud commission has made its determination. These
reports contain various types of statistics, including each
district attorney’s respective numbers of investigations, arrests,
4400 California State Auditor Report 2002-018 California State Auditor Report 2002-018 4411
and prosecutions. Despite providing some useful information,
the district attorneys’ reports are not linked to the objectives
they describe in their applications for fraud assessment funds,
and the district attorneys do not report their progress in
achieving their objectives. Therefore, the reports do not help
the fraud commission better understand the effectiveness of
each district attorney in fighting fraud. As a result, even if the
fraud commission were to receive the district attorneys’ reports
before its December meeting, the information in the reports
would be of little use in determining whether the amount
the fraud commission assessed in the prior year was actually
having the desired effect. Armed with reports that lack adequate
information, the fraud commission has no performance
measures to use when determining whether its aggregate
assessment is appropriate.
The fraud commission also does not receive adequate information
from the fraud division regarding its activities before making a
decision regarding what the aggregate fraud assessment should
be. Rather than submitting a budget outlining its funding
needs, the fraud division made a PowerPoint presentation to
the fraud commission at its December 2003 meeting, describing
its efforts and some of the results it has achieved in fighting
fraud. As part of this presentation, the division chief indicated
that for fiscal year 2002–03, the fraud division opened 827 new
cases and submitted 257 cases to county district attorneys for
prosecution. However, our review of the referrals entered into
the fraud division’s database from September 2001 through
December 2003—a period that included all of fiscal year 2002–03—
indicates that the fraud division submitted only 233 cases to
district attorneys for prosecution during the period. Moreover,
such statistics do not contain information specific enough for
the fraud commission to know whether these activities are cost-
The commission plans to effective in reducing workers’ compensation fraud or to determine
ask the fraud division the appropriate level of assessments for the coming year.
to present its budget
at the December 2004 According to the chair of the fraud commission, the commission
fraud assessment meeting plans to ask the fraud division to present its budget at the
because the fraud December 2004 fraud assessment meeting because the fraud
commission does not have commission does not have a clear picture of where the money
a clear picture of where is being spent or where it is needed. Without such information,
the money is being spent the fraud commission has little evidence to gauge whether the
or where it is needed. fraud assessment funds the fraud division receives are being used
effectively and thus whether its aggregate assessment is appropriate.
4422 California State Auditor Report 2002-018 California State Auditor Report 2002-018 4433
The Fraud Assessment Commission Has Limited Authority to
Hold the Fraud Division or District Attorneys Accountable for
Their Antifraud Efforts
The fraud commission has the final decision over the aggregate
amount to be levied against employers, and once the assessment
has been decided on, the fraud commission further decides
how the assessed funds should be allocated between the fraud
division and the grants awarded to participating county district
attorneys. According to state law, after certain incidental and
administrative costs to run the program are deducted, at least
40 percent of the annual aggregate fraud assessment must be
set aside for grants to district attorneys and 40 percent must
be provided to the fraud division. The fraud commission has
discretion as to how the remaining 20 percent is divided for
One commissioner told these two purposes. Therefore, although the fraud commission
us that she would like to decides the amount of the aggregate fraud assessment, it has
see the fraud commission little ability to hold the fraud division or district attorneys
have more discretion as to accountable for how they spend the funds. For example, if the
how it divides the funds, fraud commission were inclined to give either the fraud division
instead of being restricted or the district attorneys less funding, its discretion would be
by a formula—believing limited to a maximum of 20 percent of the aggregate amount
the added flexibility would assessed. One commissioner told us that she would like to see
allow the commission the fraud commission have more discretion as to how it divides
to better hold the fraud the funds, instead of being restricted by this formula. This
division and district commissioner believes that having this additional flexibility
attorneys accountable. would allow the commission to better hold the fraud division
and district attorneys accountable. In fiscal year 2002–03, the
fraud division received 45 percent of the funds and the district
attorneys received 55 percent.
PROCEDURES TO DETERMINE THE MOST EFFECTIVE
DISTRIBUTION OF FRAUD ASSESSMENT FUNDS
LACK ACCOUNTABILITY
Both the fraud commission and the insurance commissioner,
with the assistance of a review panel and the fraud division,
are involved in awarding grant funds to the district attorneys
participating in the workers’ compensation antifraud program.
For fiscal year 2003–04, the fraud commission consented to a
distribution totaling $17.4 million in grants of fraud assessment
funds to district attorneys. However, fraud division staff and
members of the review panel—both of whom are responsible for
evaluating district attorneys’ applications and recommending
how much grant funds each should be awarded—do not use
standard criteria to evaluate the applications or document the
4422 California State Auditor Report 2002-018 California State Auditor Report 2002-018 4433
rationale they use in reaching their respective recommendations
for distributing the funds. Further, none of the criteria used
includes measures of performance that would allow the fraud
division staff, the review panel, the insurance commissioner, and
the fraud commission to make a more informed decision on the
most effective distribution of fraud assessment funds, as the law
requires. As shown in Appendix A, the grant awards approved
by the fraud commission differ from the funds requested in
fiscal year 2003–04 for all but three of the 36 county district
attorneys that applied for grants. In addition, controls intended
to restrict the use of grant funds for county administrative
costs are not always effective. Moreover, the fraud division
and the review panel do not base their recommendations for
the distributions of fraud assessment funds to participating
district attorneys exclusively on an evaluation of the district
attorneys’ applications for the funds, as called for in Department
of Insurance regulations. Finally, although the legal division
for the Department of Insurance indicated that open-meeting
requirements may apply, the review panel held a key portion
of its July 2003 meeting to decide on district attorney funding
amounts in a closed session.
The Review Panel Has Not Implemented Procedures That
Demonstrate Assessment Funds Are Distributed Where They
Will Be Most Effective in Fighting Fraud
The process that exists for allocating fraud assessment funds to
district attorneys is based on the individual judgments of the
Rather than using members of the review panel, not on an established evaluation
standardized criteria method. Rather than using standardized criteria and justifying
and justifying their their choices, the individuals responsible for making funding
choices, the individuals recommendations to the fraud commission regarding the
responsible for making amount to be distributed to each participating district attorney
funding recommendations use personal criteria and do not document the reasons for
to the fraud commission their decisions.
regarding the amount
to be distributed to each When determining how to allocate funds to county district
participating district attorneys, the insurance commissioner convenes a five-
attorney use their own member review panel that, with the assistance of the fraud
individual criteria division, collects and reviews the applications submitted by
and do not document district attorneys who would like to participate in the workers’
the reasons for their compensation antifraud program. The application contains
recommendations. several elements, as required by Department of Insurance
regulations, including various performance statistics, the
district attorney’s plans for using the funds, and a description of
ongoing investigations and prosecutions. The panel members
4444 California State Auditor Report 2002-018 California State Auditor Report 2002-018 4455
review the applications and hold hearings to listen to individual
presentations and further question the district attorneys about
their plans for the grant funds and the results attained from
using past grant funding. Ultimately, the review panel decides
on a grant award to recommend for each participating county
district attorney and forwards its recommendations to the
insurance commissioner. Based on the recommendations of
the review panel and with the advice and consent of the fraud
division, the insurance commissioner makes his determination
on the most effective distribution of the funds. Before the
funds are distributed to the district attorneys, the insurance
commissioner forwards his decision to the chair of the fraud
commission and receives written consent.
According to the review panel members we spoke to, each
member of the panel has his or her own criteria for reviewing
the applications and making a recommendation for the funding
to be distributed to each county district attorney. The panel
members do not share their criteria or rationale with the
applicant district attorneys or the other review panelists. Thus,
the final decision reached by the review panel is based on a
consensus of separate opinions, rather than on standard criteria.
According to one former and one current member of the review
panel, one reason the panel has adopted this decision-making
A former review panel process is that it is difficult to quantify the effectiveness of a
member told us that district attorney’s efforts in fighting fraud. A former review
looking at performance panel member told us that looking at performance statistics and
statistics and expenditure expenditure plans in isolation does not give a complete picture
plans in isolation does of a district attorney’s effectiveness. For example, a conviction
not give a complete in a case of fraud by a medical provider might take years to
picture of a district investigate and prosecute, while a conviction in another type
attorney’s effectiveness. of fraud case might take only a matter of months. Thus, basing
a funding award strictly on performance statistics is of limited
value. The fraud division is currently pursuing efforts to develop
a standardized assessment method that could be used to evaluate
county district attorney performance, as discussed at the end of
the chapter.
Before fiscal year 2002–03, review panel members were asked
to complete a score sheet rating the application of each county
district attorney on a number of factors, including performance,
qualifications, and program strategy. After completing the score
sheets, the review panel submitted them to the fraud division,
which tallied the scores and ranked each application. Fraud
division staff then distributed this list to the review panel
4444 California State Auditor Report 2002-018 California State Auditor Report 2002-018 4455
members so they could see the aggregate scores and ranking.
According to fraud division staff, this rating system is no longer
used because the fraud commission now holds its meetings in
an open forum, and the division did not want the ratings of
individual district attorneys’ strengths and weaknesses to be
made a part of the public record. However, by not establishing
standardized criteria with which to evaluate county district
attorneys’ applications for antifraud program funding and
failing to document how panel members reach their collective
recommendations for distributing those funds, the review panel
is leaving itself open to the perception that the process may not
be equitable.
The Fraud Division Does Not Document Its Reasons for
Recommendations to the Review Panel for Funding Grants
to District Attorneys
According to its regulations, the Department of Insurance is
required to place the chief of the fraud division or a designee on
Because the review the review panel. The fraud division assists the chief in his role
panel and fraud division as a panel member and makes its recommendation to the review
staff that advise the panel for an amount to award each county district attorney. Like
fraud commission and the review panel, the fraud division does not use standardized
insurance commissioner criteria when evaluating the applications; instead, according to
do not document the the fraud division chief, it bases its recommendations on reviews
reasons for their decisions conducted by its staff. However, because the review panel
on the grant award and fraud division staff that advise the fraud commission and
amounts they recommend insurance commissioner do not document the reasons for their
individual district grant award recommendations, the decision-making process is
attorneys receive, the not replicable and thus lacks accountability.
decision-making process
is not replicable and According to the fraud division’s workers’ compensation
lacks accountability. bureau chief, the fraud division management instructs staff to
develop the recommendations by reviewing the applications
and assessing the adequacy of the county district attorneys’
proposals. Management also asks the chief investigators at the
fraud division’s nine regional offices to review the applications
of the district attorneys from their regions with whom they
work directly. Following their review, the chief investigators
prepare brief narratives containing their opinions of the county
district attorneys’ plans and past performance and their funding
recommendations. Fraud division staff and management then
meet to discuss their individual reviews of the applications and
the chief investigators’ narratives, ultimately arriving at a final
funding recommendation.
4466 California State Auditor Report 2002-018 California State Auditor Report 2002-018 4477
Although we found some evidence that fraud division staff
review and chief investigators comment on the district
attorneys’ applications, management in the fraud division
does not document how it uses that information to arrive at
its recommendations for funding granted to district attorneys.
According to the fraud division’s workers’ compensation
bureau chief, these recommendations act only as a starting
point for the funding discussions at the review panel hearing
and are sometimes altered by the members of the review panel
before the final recommendation is forwarded to the insurance
commissioner. We understand that these recommendations
are not the final word of the review panel, but they do provide
advice and may exert some influence over the final funding
recommendations. In fact, as shown in Appendix A, for 19 of
the 36 county district attorneys that the review panel considered
for funding in fiscal year 2003–04, the review panel agreed with
the fraud division’s recommendations. Without documenting
how it arrives at these recommendations, the fraud division leaves
itself open to the perception that the process may not be fair.
Controls Intended to Restrict County District Attorneys’ Use
of Grant Funds Are Not Always Effective
Decision makers who evaluate applications from county
Decision makers who district attorneys for fraud assessment grants and recommend
evaluate applications funding for the grants—the fraud division, review panel,
from county district insurance commissioner, and fraud commission—do not always
attorneys for fraud ensure that the county district attorneys follow Department
assessment grants and of Insurance regulations intended to limit charges of county
recommend funding indirect costs, such as those costs for county administrative
for these grants do not services, to grants of fraud assessment funds. Specifically,
always ensure that the the regulations give county district attorneys three options
county district attorneys for charging county indirect costs to workers’ compensation
follow Department of fraud assessment grants: (1) they can charge indirect costs in
Insurance regulations compliance with cost allocation plans required by the federal Office
intended to limit charges of Management and Budget (OMB) Circular A-87 for federal
of county indirect costs, domestic assistance programs—a plan that is negotiated with
such as those costs for federal agencies without input from the fraud commission or the
county administrative insurance commissioner; (2) they can charge up to 10 percent
services, to grants of of salaries and wages, excluding the costs of employees’ benefits
fraud assessment funds. and overtime; or (3) they can charge up to 5 percent of total
direct program costs.
We reviewed the applications from 10 of the counties that
received the largest grants for fiscal year 2003–04 and found that
the district attorneys for Alameda and San Bernardino counties
4466 California State Auditor Report 2002-018 California State Auditor Report 2002-018 4477
and the City and County of San Francisco did not include
in their grant applications whether or how they proposed to
charge indirect costs to the grants they were applying for, and
audited expenditure reports for the grants do not show these costs
separately. As a result, decision makers who reviewed these three
applications could not have known whether the indirect costs the
district attorneys planned to charge to their grants met with the
regulations for the program. The grants to the three county district
attorneys accounted for about $2.5 million, or nearly 15 percent of
the funds awarded to district attorneys for fiscal year 2003–04.
Moreover, the program’s regulations do not appear to provide
the restrictions on charges of indirect costs that the fraud
The program’s regulations commission expects. For example, the district attorney’s office
do not appear to provide for Los Angeles County indicated in its fiscal year 2003–04 grant
the restrictions on charges application that it planned to charge its county indirect costs to
of indirect costs that the its grant at a rate of 43 percent of the costs of salaries and wages
fraud commission expects. charged to the program—a rate it claimed was in compliance
with OMB Circular A-87 and, therefore, with Department of
Insurance regulations. However, as we discuss in Chapter 2,
the annual independent audit reports submitted by county
district attorneys do not ensure that county district attorneys
have used fraud assessment funds in accordance with program
requirements. As a result, the fraud commission and the fraud
division do not know whether Los Angeles County’s indirect
cost percentage does indeed comply with program regulations.
Under its proposed budget, the Los Angeles County district
attorney’s office charges the antifraud program funds directly
for the costs of the salaries, wages, and benefits for staff who work
in the program. The district attorney’s office calculates its charges
for most of the support services for those employees, identified
as operating costs, by multiplying its indirect cost rate times the
costs of salaries and wages. Unlike most of the other county district
attorneys in the antifraud program whose budgets we reviewed,
the Los Angeles County district attorney does not separate the
support services that can be directly identified to the employees
who work on the program, and whose salaries are directly charged
to the program, from the support costs that cannot be separately
identified and must be indirectly charged through an allocation
process. Instead, it charges most of its operating costs to the
antifraud program using its indirect cost rate.
Using its indirect cost rate of 43 percent, Los Angeles County’s
proposal for fiscal year 2003–04 included almost $1.5 million
for allocated operating costs, out of a total proposed budget of
4488 California State Auditor Report 2002-018 California State Auditor Report 2002-018 4499
just over $6.3 million. In addition to allocated costs, Los Angeles
County charges fraud assessment grants for travel, training,
audit fees, and parking to arrive at total operating costs of
$1.55 million, representing slightly more than 44 percent
of the salaries and wages charged directly to the antifraud
program. To identify the effect of the Los Angeles County
district attorney’s method for charging costs, we attempted
to recalculate its total operating costs using the two other
options allowed by Department of Insurance regulations for
calculating indirect costs. However, as previously discussed, the
information provided by Los Angeles County did not allow for
such a recalculation because it did not separately identify direct
program costs from indirect costs.
Therefore, we compared Los Angeles County’s operating
expenses to those charged by district attorneys in two other
high-cost counties, Santa Clara and San Diego. These two county
district attorneys separately identify their direct and indirect
Our comparison costs and calculate their indirect costs using the option that
revealed that the ratio allows 10 percent of salaries, excluding benefits and overtime.
of Los Angeles County’s Our comparison reveals that the ratio of Los Angeles County’s
proposed operating proposed total operating expenses to its costs for salaries
expenses to its costs for and wages was roughly twice those of these other high-cost
salaries and wages was counties: Santa Clara County at 21 percent of salaries and wages
roughly twice that of two and San Diego County at 20 percent of salaries and wages. Using
other high-cost counties. the third option to calculate indirect costs—5 percent of total
direct costs—resulted in even lower indirect costs for Santa Clara
and San Diego counties.
The primary difference between the three options is that the
formula for the second and third options includes a cap on
indirect costs that is defined by Department of Insurance
regulations. In contrast, the first option, which allows the use
of indirect cost rates under OMB A-87, is based on an indirect
countywide cost rate that is negotiated and approved by a federal
agency, without any input from the fraud commission or the
fraud division. Consequently, the restrictions present in the
second and third options are, for the most part, absent from the
first option, producing, in the case of the indirect costs proposed
by the Los Angeles County district attorney, a very different result.
In its December 2003 meeting to determine the aggregate
assessment for the workers’ compensation antifraud program for
fiscal year 2004–05, members of the fraud commission questioned
the representative from the Los Angeles County district attorney’s
office on the high indirect cost rate. The representative responded
4488 California State Auditor Report 2002-018 California State Auditor Report 2002-018 4499
that the indirect costs in the district attorney’s proposal included
office space, phones, desks—everything that needs to be provided
to a group of employees except salaries and benefits. He further
stated that the indirect cost rate complied with federal
guidelines and that the Los Angeles County board of supervisors
had instructed the district attorney’s office to apply this rate to the
workers’ compensation fraud assessment grant. The representative
stated that under Los Angeles County’s understanding of the
program’s regulations, the county was entitled to charge
a 43 percent indirect cost rate, and that the fraud commission
should change the regulations if it felt this rate was unacceptable.
The minutes of this meeting did not contain any discussion that
led to a resolution of the issue. Despite the apparent disagreement
between the fraud commission and the Los Angeles County district
attorney about the appropriate amount of indirect costs that should
be charged to the fraud assessment grant, Los Angeles County was
awarded $4.3 million for fiscal year 2003–04—roughly 25 percent of
the total funds available to county district attorneys that year.
Recommendations for Some of the Grant Funding Received by
District Attorneys Are Not Based Exclusively on Evaluations of
Their Applications
The fraud division and the review panel do not base their
recommendations on the distribution of fraud assessment funds
to participating district attorneys exclusively on evaluations of
the district attorneys’ applications for the funds, as called for
in the regulations. The grant awards made to district attorneys
are made up of two components: (1) a base allocation derived
from a formula delineated in the Department of Insurance
regulations and (2) a program award based on the specifics of
each district attorney’s plan to investigate and prosecute fraud.
The fraud division believes that the review panel must grant
Apparently based on legal base allocations without evaluating the content of each
advice received in the district attorney’s application, as long as the county sends
early days of the program, in a completed application within the time limit prescribed.
the fraud division believes According to a manager in the fraud division, this belief is
that the review panel apparently based on legal advice the fraud division received
must recommend base in the early days of the program. Moreover, a section of
allocations as long as Department of Insurance regulations states that if the review
the county sends in a panel finds that the county district attorney has failed to
completed application respond adequately to the required items, the panel may
within the time recommend funding at the base allocation level. However,
limit prescribed. this section of the regulations contains an erroneous reference.
Section 2698.57 states, “if the county plan fails to respond
5500 California State Auditor Report 2002-018 California State Auditor Report 2002-018 5511
adequately to the required items as specified in sections 2693.6
and 2693.7, the panel may recommend funding at the district
attorney’s base allocation level.” However, sections 2693.6
and 2693.7 do not exist in the Department of Insurance
regulations. Therefore, if these are the criteria used by the panel
to recommend funding levels, we are unsure of the basis for
the recommendations.
Furthermore, another section of the regulations is quite clear
that both the base allocations and the program awards to district
attorneys must be based on evaluations of the counties’ plans
included in the applications for funding. Because of the fraud
division’s interpretation of the regulations and its instructions
to the review panel, 50 percent of the funds available for district
attorneys, or more than $7 million for fiscal year 2002–03,
was recommended for distribution by the review panel based
merely on the fact that the counties had completed the required
portions of their applications.
The Review Panel Does Not Always Comply With Open-Meeting
Requirements When Developing Its Funding Recommendations
Before 2002, the review panel’s process of developing funding
recommendations for county district attorneys included holding
closed hearings at which the district attorneys would present
specific information about various aspects of their workers’
compensation antifraud programs, including planned and
ongoing investigations. Members of the review panel told us
that having these meetings closed to the public enabled them
to ask the district attorneys pointed questions about ongoing
investigations and resource allocations without jeopardizing the
district attorneys’ confidentiality requirements. The review panel
members believe the freedom to ask these questions enabled the
panel to determine a more effective allocation of resources.
However, beginning in September 2002, the review panel began
holding its meetings in open session because the fraud division
indicated to the fraud commission that the review panel’s closed
meetings might be in violation of open-meeting laws. Even
though legal counsel for the Department of Insurance is not
certain that the Bagley-Keene Open Meeting Act (Bagley-Keene)
applies to the review panel, the fraud division requested that the
panel discontinue conducting closed hearings. Our own legal
counsel is of the opinion that the review panel is subject to the
Bagley-Keene provisions and would require a specific exemption
from the act to conduct part of its hearings in closed session to
5500 California State Auditor Report 2002-018 California State Auditor Report 2002-018 5511
discuss criminal investigations that are by law confidential. The
Contrary to the panel members we spoke with said they are reticent, in an open-
Department of Insurance meeting forum, to ask district attorneys questions about ongoing
legal counsel’s advice investigative efforts for fear of hampering their investigations.
that the review panel’s Thus, the review panel’s ability to obtain the information it
closed meetings might be needs to effectively distribute the funding is limited.
in violation of the Bagley-
Keene Open Meeting Act, Although the Department of Insurance legal counsel is uncertain
in its July 2003 meeting whether Bagley-Keene provisions apply, the fraud division
the review panel appeared has instructed the review panel and the district attorneys to
to determine its final proceed as though the provisions do apply. Nevertheless, in its
funding recommendation July 2003 meeting, the review panel appeared to determine
in closed session. its final funding recommendations for fiscal year 2003–04 in
closed session. We reviewed the minutes of this meeting and found
that after the district attorneys had made their presentations,
but before the panel members began discussing specific funding
recommendations, the panel took a break. Once the panel
members reconvened the meeting, they had arrived at final
funding recommendations, which was passed by a majority vote.
One member of the review panel confirmed that during this break,
the panel members had discussed the funding recommendations
and arrived at final decisions in a closed session.
The Fraud Division Is Developing Performance Measures to
Help It Evaluate Its Own Effectiveness and That of the County
District Attorneys in Reducing Fraud
In a recent memorandum, the chief of the fraud division stated
that the division is working to establish a set of performance
metrics to better evaluate the effectiveness of the fraud division
and participating district attorneys in reducing the overall cost
of workers’ compensation fraud. The fraud division’s workers’
compensation bureau chief told us that the division was in
the process of amending an existing consultant contract to
help develop performance measures. However, at the time of
our review, the fraud division and its consultant had not yet
developed the performance measures sufficiently for us to
evaluate them or comment on their potential effectiveness for
the purposes listed in the fraud division chief’s memorandum.
We contacted two members of the fraud commission to discuss the
commission’s position on developing a method of measuring
the performance of the fraud division and the district attorneys
that could be used in awarding grants of fraud assessment
funds. One fraud commission member stated that there would
be limited value in implementing such a system using the
5522 California State Auditor Report 2002-018 California State Auditor Report 2002-018 5533
performance statistics currently collected. According to this
commission member, merely looking at the number of arrests,
even if they are segregated by the type of case, is not enough
to determine whether one district attorney is more effective
than another. Therefore, any measures of performance using
the type of data the fraud division currently collects, such as
arrest statistics, would be of limited use. However, we believe
additional information on performance, such as success in
attaining the stated objectives of the fraud commission and
the insurance commissioner, would be beneficial to the fraud
commission in evaluating the performance of county district
attorneys and the fraud division.
The chair of the fraud commission stated that the fraud
commission has not really delved into the subject of
accountability and funding for the fraud division. He added
that this year would be the first time the fraud commission
would be asking the fraud division to account for its activities.
He stated that to hold the fraud division accountable, the fraud
commission could reduce the fraud division’s funding, but he
did not believe such an action would really be effective.
RECOMMENDATIONS
To better determine the assessment to levy against employers
each year for use in reducing fraud in the workers’ compensation
system, the fraud commission and the insurance commissioner
should direct the fraud division to measure the nature and
extent of fraud in the workers’ compensation system. To
establish benchmarks to gauge the effectiveness of future
antifraud activities, these measures should include analyses of
available data from insurers and state departments engaged
in employment-related activities, such as Industrial Relations
and the Employment Development Department. In addition,
the insurance commissioner should consider reactivating
an advisory committee comprising stakeholders focused
on reducing fraud in the workers’ compensation system to
contribute to the data analyses, provide input about the effects
of fraud, and suggest priorities for reducing it. This advisory
committee should meet regularly and in an open forum to
increase public awareness and the accountability of the process.
Given the nature and extent of fraud in the system, the fraud
commission and the insurance commissioner and his staff
should design and implement a strategy to reduce workers’
5522 California State Auditor Report 2002-018 California State Auditor Report 2002-018 5533
compensation fraud. The strategy should be systemwide in scope
and include goals, objectives, priorities, and measurable targets
that can be effectively communicated to the fraud division
and the county district attorneys participating in the antifraud
program. Efforts to achieve the strategy targets should be both
a condition for receiving awards of fraud assessment funds and a
measure of how well the fraud division and the county district
attorneys pursue the systemwide objectives. The strategy should
clearly define the roles and responsibilities of the participants in
antifraud activities.
To gather the information necessary to make its decision on the
annual amount to be assessed from employers to fight fraud
in the workers’ compensation system, the fraud commission
should take the following steps:
• Revamp its decision-making process so that it includes the best
information available, including (1) the results of the
Department of Insurance’s analyses of the nature and extent
of fraud in the workers’ compensation system, once they are
completed; (2) analysis of the effectiveness of efforts by the fraud
division and district attorneys in the prior year to reduce fraud
in accordance with their respective program objectives; and (3)
any newly emerging trends in fraud schemes that should receive
more attention.
• Request an annual report from the fraud division that outlines
(1) its prior year objectives linked to measurable outcomes
and (2) its objectives for the ensuing year, together with
estimates of the expenditures the fraud division needs to
make to accomplish those objectives.
• Request, in addition to the information currently required
of each county district attorney planning to participate in
the antifraud program, a report listing the district attorney’s
accomplishments in achieving the goals and objectives outlined
in the prior year’s application and the goals and objectives for
the ensuing year. The report should also include the estimated
cost of the grant year’s activities to achieve the district attorney’s
goals and objectives and a description of how those goals and
objectives align with the program goals described by the fraud
commission and the insurance commissioner.
If the fraud commission believes that altering the funding
formula from the statutorily required levels—under which
40 percent of fraud assessment funds are automatically awarded
to both the fraud division and the district attorneys—would
5544 California State Auditor Report 2002-018 California State Auditor Report 2002-018 5555
increase accountability over the use of antifraud program
funds, it should encourage legislation that would allow it more
discretion in how these funds are distributed.
To better ensure that fraud assessment funds are distributed to
district attorneys so as to most effectively investigate and
prosecute workers’ compensation fraud and increase their
accountability in using the funds, the fraud commission and the
insurance commissioner should take the following steps:
• Develop and implement a process for awarding fraud
assessment grants that provides consistency among those
making funding recommendations by incorporating standard
decision-making criteria and a rating system that supports
funding recommendations.
• Include in the decision-making criteria how well the county
district attorneys’ proposals for using fraud assessment
funds align with the strategy and priorities developed by
the fraud commission and the insurance commissioner, as
well as the district attorneys’ effectiveness in meeting the
prior year’s objectives.
• Document the rationale for making decisions on
recommendations for grant awards.
• Reevaluate the Department of Insurance regulations pertaining
to how indirect costs are charged to fraud assessment grants to
determine whether the regulations provide the desired
amount of control. The fraud commission and the insurance
commissioner should also seek changes in the regulations if
required and ensure that all county district attorneys that apply
for fraud assessment grants disclose their methods of charging
indirect costs.
• Change the past policy of awarding the base portion of fraud
assessment grants to county district attorneys exclusively
on whether they submitted a completed application by
the required deadline and instead, make recommendations
for total grant awards, including the base allocations, on
evaluations of county district attorneys’ plans that include
how they will use the funds, as required by Department of
Insurance regulations.
• Determine whether the Bagley-Keene provisions apply to
the review panel’s meetings to recommend fraud assessment
grants to county district attorneys and, if they do, seek a
5544 California State Auditor Report 2002-018 California State Auditor Report 2002-018 5555
specific exemption for discussions of portions of the county
district attorneys’ applications for grant awards that include
confidential criminal investigation information. The parts of
the meeting discussing recommendations for district attorney
funding levels should remain open to the public, however,
and the fraud commission and the insurance commissioner
should ensure that the review panel complies with the
requirements of Bagley-Keene.
• Continue current efforts to establish performance measures
to use in evaluating the effectiveness of the fraud division
and participating district attorneys in reducing workers’
compensation fraud. The measures could also assist in
(1) determining the appropriate amount of funds to
be assessed and divided between the fraud division and
grants for county district attorneys and (2) determining
recommendations for grant awards to the county district
attorneys and the fraud division. n
5566 California State Auditor Report 2002-018 California State Auditor Report 2002-018 5577
CHAPTER 2
Lacking Adequate Strategic Planning,
the Fraud Division Has Not Met All
Its Responsibilities for the Workers’
Compensation Antifraud Program
CHAPTER SUMMARY
Because the Department of Insurance’s Fraud Division
(fraud division) has not conducted adequate strategic
planning for its workers’ compensation antifraud
activities, it has not met all its noninvestigative responsibilities
and spends a significant portion of its workers’ compensation
fraud resources investigating suspected fraud referrals that do
not result in criminal prosecutions by county district attorneys.
The fraud division pays for its workers’ compensation antifraud
activities using its share of the funds from the fraud assessment
levied against California employers. Over the five years ending
fiscal year 2002–03, the fraud division’s portion of the fraud
assessment funds averaged more than $13 million per year.
Comprehensive strategic planning would require that the fraud
division (1) take specific steps to identify all its responsibilities for
the workers’ compensation antifraud program, (2) establish and
prioritize goals and define the necessary objectives to accomplish
them, (3) establish timelines and action plans for completing
each objective and allocate the available resources based on its
priorities, and (4) define benchmarks for each activity that can
be used to evaluate performance outcomes and reset targets. The
fraud division has largely left all these tasks undone.
Because it has not used a strategic approach to planning, the
fraud division dedicates too few resources to the noninvestigative
activities required to meet its statutory responsibilities. For
example, the fraud division has made little attempt to conduct
the research necessary to measure the magnitude of fraud by
type—research that could guide the fraud division’s approach
and measure its actions and effectiveness in reducing the
fraud problem. Further, the fraud division has not developed
the information on fraud it requires to prepare reports for
individuals and entities overseeing the program, such as the
insurance commissioner, the Legislature, and the Fraud
Assessment Commission (fraud commission). However, the fraud
5566 California State Auditor Report 2002-018 California State Auditor Report 2002-018 5577
division’s ability to successfully identify goals and objectives
is somewhat limited because, as discussed in Chapter 1, the
fraud commission and the insurance commissioner have not
established a statewide strategy for the antifraud program.
Although the fraud division dedicates the majority of
its workers’ compensation resources to investigating suspected
workers’ compensation fraud, it does not submit a large
percentage of the referrals it receives to county district
attorneys for prosecution. Moreover, for many referrals of
suspected high-impact fraud—the types of fraud that the
insurance commissioner believes are the most costly to
the workers’ compensation system—the fraud division closes the
case without performing an investigation because of a lack of
evidence, or it investigates the case but does not refer it to a
district attorney for prosecution.
Further, the fraud division does not adequately monitor district
attorneys’ use of workers’ compensation fraud assessment funds.
Each district attorney participating in the antifraud program
must provide the fraud division with an annual financial audit
report that includes certification that the district attorney used
the fraud assessment funds in compliance with applicable
laws and regulations and the conditions contained in the
application for a fraud assessment grant. However, the fraud
division does not consistently enforce the requirement that
the audit reports include the required certification; therefore,
many do not, leaving the fraud division with no assurance that
fraud assessment funds awarded to district attorneys are used in
accordance with program requirements.
An audit unit within the Department of Insurance also performs
reviews of district attorneys’ use of workers’ compensation
fraud assessment funds that have resulted in the detection and
recovery of questionable expenditures, but the audit unit’s
coverage of district attorneys is limited because it does not have
sufficient staff to audit all district attorneys that receive workers’
compensation fraud assessment grants on a regular basis.
THE FRAUD DIVISION HAS NOT CONDUCTED
STRATEGIC PLANNING TO ENSURE THAT IT
MEETS ITS RESPONSIBILITIES
As a result of poor strategic planning, the fraud division has not
met all its statutory responsibilities in areas that include research,
grant administration, and auditing insurers’ compliance with
5588 California State Auditor Report 2002-018 California State Auditor Report 2002-018 5599
reporting suspected fraud. Strategic planning is a long-term,
future-oriented process of assessment, goal setting, and decision
making that maps an explicit path between the present
and a vision of the future. Essential elements
of sound strategic planning include analyzing
the environment, defi ning a mission and goals,
Essential Elements of Strategic Planning
establishing priorities among goals and allocating
• Identify responsibilities, strengths, resources, and measuring actual performance against
weaknesses, problems, and opportunities.
predefi ned benchmarks (see the text box).
• Defi ne the mission and formulate goals
consistent with the mission.
A strategic plan should focus on outcomes or
• Identify key issues relating to the mission
benefi ts derived from the efforts expended rather
and the planned activities.
than on the efforts themselves. A successful
• Establish priorities among the goals and
planning process provides many benefi ts to both
allocate resources accordingly.
the agency and the clients the agency serves.
• Defi ne the objectives necessary to achieve
each stated goal. Strategic planning improves an agency’s ability
to anticipate and accommodate the future by
• Establish timelines and action plans to
complete each objective. identifying issues, opportunities, and problems.
• Defi ne benchmarks or targets for each Good planning also enhances decision making at
appropriate activity. both the operational and executive management
• Measure the results of planned operations levels because it focuses on results, provides
against the benchmarks to evaluate
information to guide managers in making resource
performance and reset targets as necessary.
allocation decisions, and establishes a basis for
measuring the success of the agency’s activities.
Finally, the fundamental concept underlying
strategic planning is its dynamic nature. The planning process
is not a one-time project that, once completed, remains static.
Instead, it should be an iterative process that is refi ned and
refocused as performance is measured, targets are reset, and new
information becomes available.
The Fraud Division’s Business Plan Does Not Adequately
Defi ne Its Responsibilities
Instead of a strategic plan, the fraud division has
developed a business plan. The business plan
Fraud Division’s Mission Statement
contains the fraud division’s mission, a single
To protect the public from economic loss and goal—to be the best consumer protection agency
distress by actively investigating and arresting in the nation and enforce workers’ compensation
those who commit insurance fraud and to
fraud laws vigorously, effectively, and fairly—and
reduce the overall incidence of insurance
fraud through antifraud outreach to the three objectives relating specifi cally to workers’
public, private, and governmental sectors.
compensation fraud and one applicable to all types
of fraud.
Source: Fraud Division Business Plan (revised
January 2004). We discovered that many of the fraud division’s
noninvestigative functions are neither included
in the fraud division’s mission statement nor well
5588 California State Auditor Report 2002-018 California State Auditor Report 2002-018 5599
defi ned in its business plan and, as a result, are
understaffed or nonexistent. As shown in the text
Goal and Objectives Defi ned in the box on the previous page, the fraud division’s mission
Fraud Division’s Business Plan speaks only to investigations, arrests, and outreach
and does not include its noninvestigative functions,
Goal:
which are meant to ensure that investigations
• To be the best consumer protection agency
are carried out effectively and effi ciently. We
in the nation and to enforce workers’
compensation fraud laws vigorously, reviewed the fraud division’s business plan (revised
effectively, and fairly.
January 2004) and found that although the fraud
Objectives directly related to workers’ division recognizes that its organizational purpose
compensation fraud or to fraud in general:
is to provide all investigative and support services
• To reduce overall workers’ compensation
necessary to implement and manage the workers’
costs to employers by increasing the
investigations of high-impact cases by compensation antifraud program, the business plan
10 percent over the prior year. does not specifi cally defi ne what that means. For
• To decrease the cost of workers’ example, it makes no mention of its advisory role to
compensation insurance in California by
the Legislature and the fraud commission, or to the
working with insurance companies to increase
the number of insurance fraud referrals to the research function needed to obtain the information
fraud division by 10 percent. necessary to guide its approach in fi ghting fraud and
• To implement a pilot project to to provide reliable advice. In addition, although the
improve outreach efforts in the workers’
fraud division’s business plan recognizes that its local
compensation insurance industry by
educating the roofi ng and construction assistance unit oversees the workers’ compensation
industry on detecting workers’ compensation grant program that provides fraud assessment
fraud schemes, including premium fraud.
funds to participating county district attorneys,
• To ensure that quality cases are assigned
its responsibility as a grant administrator is not
and to preclude the creation of a case
backlog, the fraud division will increase specifi cally defi ned.
by 10 percent the number of suspected
fraudulent claims reviewed by supervisors
for investigation or disposition.
The Fraud Division Has Not Established the
Goals and Objectives Necessary to Meet All
Its Responsibilities
In its January 2004 revised business plan, the fraud division
identifi ed some key issues for the workers’ compensation
antifraud program, but it did not develop suffi cient goals or
objectives to address the key issues or to remedy problems it
recognized. In fact, the fraud division’s business plan has only
one goal and four objectives that either specifi cally address
workers’ compensation fraud or address fraud in general (see the
text box). However, neither its goal nor its objectives are specifi c
enough to provide suffi cient direction for the fraud division’s
antifraud efforts.
In the section of its business plan that analyzes its performance,
the fraud division lists key limitations in implementing the
workers’ compensation antifraud program but does not
adequately identify goals and objectives for addressing each
limitation. For example, the fraud division acknowledges that
6600 California State Auditor Report 2002-018 California State Auditor Report 2002-018 6611
some of the external criticisms of the division include that it
is not investigating all cases, that case investigations take too
long, and that the fraud division does not provide a return
on investment. However, the fraud division did not adopt or
amend any goals, objectives, or actions to address these issues
in its business plan, particularly, an objective or action to
measure the magnitude of the problem of fraud in the workers’
compensation system or to develop a way to quantify the results
of its antifraud efforts so as to demonstrate their value.
Moreover, the fraud division states in its business plan that the
insurance industry is not consistently referring suspected fraud
claims to the division and is actively opposing new or modified
regulations regarding that requirement. In fact, the fraud
division acknowledges that the insurance industry might take
legal action to suspend enactment of permanent regulations.
Although one of the fraud division’s objectives speaks to
working with insurers to increase the number of fraud referrals
they submit, the action plan to accomplish this objective
does not address the need to resolve any differences between
the fraud division’s definition of what constitutes fraud and
its standards regarding the evidence necessary to successfully
investigate and prosecute fraud and the insurers’ concerns in
those areas.
The business plan is silent regarding how the fraud division
can use its special investigative audit unit to improve insurers’
The business plan is compliance with requirements for reporting suspected fraud.
silent regarding how the The fraud division identified as a weakness that, because of
fraud division can use budget constraints and limited resources, its special investigative
its special investigative audit unit would not be able to audit all insurers in the
audit unit to improve foreseeable future. Even though it has the authority to charge
insurers’ compliance with insurers for the costs of reviewing their special investigative
requirements for reporting units, the fraud division did not plan a way to minimize or
suspected fraud. overcome this weakness, and, as we discuss in Chapter 3, it does
not review a significant number of insurers.
Some of the objectives that the fraud division has included in its
business plan for the workers’ compensation antifraud program
will not necessarily accomplish their stated outcomes even if
the objectives are achieved. For example, the fraud division has
established an objective to reduce overall workers’ compensation
costs to employers by increasing by 10 percent the number of
investigations of high-impact cases—those suspected fraud cases
that include multiple suspects, involve a medical provider or
attorney, or result in large losses—over the prior year. However,
6600 California State Auditor Report 2002-018 California State Auditor Report 2002-018 6611
merely investigating more suspected high-impact fraud cases
Some of the objectives than were investigated in the prior year will not necessarily
that the fraud division produce the outcome of reducing the overall cost that fraud
has included in its adds to the system and is paid for by employers. Furthermore,
business plan for the this objective cannot produce measurable results. The objective
workers’ compensation aims to reduce cost drivers in the workers’ compensation system,
antifraud program but because the fraud division has not attempted to measure the
will not necessarily magnitude or economic cost of fraud in the workers’ compensation
accomplish their stated system or the effect of its antifraud efforts, it cannot measure any
outcomes even if the reductions in fraud that its efforts may prompt.
objectives are achieved.
The fraud division’s stated objective of decreasing the cost of
workers’ compensation insurance by working with insurers to
increase the number of referrals of suspected fraud is similarly
flawed. Simply increasing the number of referrals will not
necessarily decrease the cost of workers’ compensation insurance.
In fact, many of the referrals the fraud division currently receives
do not result in prosecution by district attorneys.
Finally, the fraud division’s ability to set goals and objectives
is limited because, as we discussed in Chapter 1, the fraud
commission and the insurance commissioner have not established
a statewide strategy and defined roles and responsibilities of the
participants in the workers’ compensation antifraud program that
would better support the annual assessment levied on employers
and ensure the most effective use of these funds. As a result,
the insurance commissioner’s priority for the fraud division
to pursue more high-impact cases presents another challenge to
fraud division management, because the district attorneys are not
required to pursue the insurance commissioner’s priorities as a
condition for receiving fraud assessment funds. Therefore, to avoid
using limited resources on cases that will not be prosecuted, the
fraud division must, to some degree, conform its activities to
the priorities of the district attorneys who prosecute its cases, not
necessarily to the insurance commissioner’s priorities.
The Fraud Division Does Not Allocate Its Resources to Meet Its
Responsibilities or Establish Adequate Performance Measures
Although the fraud division recognizes that its resources
are limited, it does not allocate the resources it does have to
minimally meet all of its responsibilities. For example, the fraud
division acknowledges in the January 2004 revision of its business
plan that it does not have the budget or personnel resources
to investigate all cases or audit all insurers for compliance with
fraud reporting requirements. It also acknowledges that its
managers need to continue to learn to use all resources—capital,
6622 California State Auditor Report 2002-018 California State Auditor Report 2002-018 6633
information, time, and people. Moreover, the fraud division’s local
Although the fraud assistance unit—the unit responsible for administering various
division recognizes that it fraud assessment grants to county district attorneys—has such
does not have unlimited limited resources allocated to it that it uses the fraud division’s
resources, it does not research specialist to assist in gathering and compiling information
allocate the resources it from county district attorneys and to provide what information is
does have to meet all of available on the use of fraud assessment funds to investigate and
its responsibilities. prosecute fraud. As a result, the research specialist is not available
to conduct the type of research needed to identify the nature
and extent of workers’ compensation fraud and develop ways to
establish baselines that can be used to measure the effectiveness
of antifraud efforts. Also, as we discuss in Chapter 3, the special
investigative audit unit does not have adequate staff to perform the
necessary number of audits to provide assurance that insurers are
complying with fraud-reporting requirements, another of the fraud
division’s responsibilities. Thus, the fraud division is not dedicating
sufficient resources to its noninvestigative functions to even
minimally accomplish them. In fact, in the section in the business
plan covering budget and resource analyses, the fraud division
indicates a need for increased staff resources to perform additional
investigations but fails to recognize a need for more resources to
perform these noninvestigative activities.
In addition, the fraud division does not adequately measure its
effectiveness in reducing fraud or its performance in meeting
its goal and objectives. For example, it has not developed a
meaningful way to measure the effect of its activities on the
overall cost of fraud to the workers’ compensation system—that
is, the return on investment of the fraud assessment funds.
The fraud division’s bureau chief for workers’ compensation
told us that the fraud division evaluates its performance and its
effectiveness in reducing fraud by using the statistics it compiles
for its annual reports and for reports to the fraud commission
of the actual caseload it works and the results of that caseload.
For instance, the fraud division annually reports to the fraud
commission and the Legislature on the number of referrals it
has investigated and the number of referrals it has submitted
to district attorneys for prosecution. Although these statistics
may give some indication of the sources of fraud that might be
taken out of the system, they do not indicate whether the fraud
division’s efforts have lowered the overall cost that fraud adds
to the system, as would the techniques we describe in Chapter 1.
The chief of the fraud division acknowledged that a baseline
measurement for monitoring performance and justifying cost
could be made but added that the fraud division has neither
the expertise nor the resources necessary to conduct the
needed analysis.
6622 California State Auditor Report 2002-018 California State Auditor Report 2002-018 6633
Likewise, as stated in its business plan, the fraud division
measures its success in educating employers in the roofing
and construction industries by using activity measures such
as counting the number of these employers attending fraud
division seminars. However, the fraud division does not develop
the types of measures that would determine whether its
outreach efforts have reduced the overall incidence of insurance
fraud, as the fraud division defined in its mission statement.
Such a measure might consist of statistical trends on the number
of fraud referrals it received for a targeted industry or reduction
in the type of fraud that the fraud division’s outreach was
focused on, collected both before and after the outreach effort.
Another objective in the business plan is to increase the number
of referrals reviewed by supervisors to ensure that quality cases
are assigned to investigators and to preclude the development
of a case backlog. However, the measurements it has defined
to determine its success in achieving this objective include
keeping tallies of referrals received, referrals backlogged, and
referrals that contain errors, as well as tracking the number of
insurers and others it contacts regarding errors in referrals and
performing quarterly reviews of pending referrals. Such activities
do not incorporate steps that the fraud division supervisors
could use to ensure that cases assigned for investigation are
of high quality. Instead of focusing its actions on why many
referrals are of low quality and correcting the problem, the fraud
division has chosen to track a variety of activities that will do
nothing to improve the quality of its referrals.
THE FRAUD DIVISION DOES NOT MEET ALL ITS
NONINVESTIGATIVE RESPONSIBILITIES
Not only does the fraud division substantially ignore
It is clear from the statutes noninvestigative functions in its business plan, but it also fails
that created the workers’ to allocate enough resources to these activities to ensure that it
compensation antifraud at least minimally meets its responsibilities. For example, it is
program that the clear from the statutes that created the workers’ compensation
Legislature intended for antifraud program that the Legislature intended the fraud
the fraud division to play division to play an important advisory role in decisions
an important advisory regarding the level of funding and the direction of the fraud
role in decisions regarding reduction efforts. Sections of the Insurance Code state that the
the level of funding and fraud division will provide advice to the fraud commission
the direction of the fraud and the insurance commissioner, report to the governor through
reduction efforts. the insurance commissioner’s annual report on the economic
impact of fraud, and make recommendations for reducing
6644 California State Auditor Report 2002-018 California State Auditor Report 2002-018 6655
insurance fraud. These sections show that the Legislature and
governor look to the fraud division for research regarding the
measurement of fraud and fraud reduction activities in the State.
However, the fraud division has not conducted such research to
Rather than draw on provide advice and information as required, nor does it maintain
the skills listed in his a research function capable of doing so.
job description, such as
developing databases For example, the fraud division does not always use its research
containing suspected specialist to study workers’ compensation issues and has not
fraud claims, identifying gained the capability to conduct the research activities necessary
trends in insurance to measure the extent and nature of workers’ compensation
fraud, and designing fraud, evaluate the effectiveness of the fraud division’s and
statistical and survey district attorneys’ efforts to deter fraud, and develop the
techniques and training information mandated by law. Rather than drawing on the skills
staff in their use, the listed in the job description, such as developing databases
fraud division’s research containing suspected fraud claims, identifying trends in
specialist spends the insurance fraud, and designing statistical and survey techniques
majority of his time and training staff in their use, the fraud division’s research
working in a unit specialist spends the bulk of his time working in a unit that
that administers local administers local assistance grant funds and serving as the
assistance grant funds. coordinator of the workers’ compensation antifraud program
in which county district attorneys participate. The research
specialist is working in the local assistance unit because that unit
is not adequately staffed to perform all its duties.
According to the fraud division’s bureau chief for workers’
compensation, the reason the division is not measuring
performance and performing research is that the division does
not have the expertise and resources necessary to conduct such
analysis. As of February 2004, the fraud division moved one staff
person from another unit to the local assistance unit to take
over the local assistance work that was being performed by the
research specialist.
As we mentioned earlier, two objectives relating to the fraud
division’s business plan seek to reduce the overall cost of the
workers’ compensation system to employers, but because it
has not attempted to measure the economic cost of fraud in
the workers’ compensation system, the fraud division cannot
measure the effects of its antifraud efforts. In fact, the fraud
division has taken the position that measuring fraud is too
difficult. In October 2003, it drafted an issue memorandum
in which it recognized that knowing the scope of workers’
compensation fraud is valuable to choosing wisely among
alternate courses of action and allocating resources effectively.
However, the memo primarily discussed the reasons why
6644 California State Auditor Report 2002-018 California State Auditor Report 2002-018 6655
estimating the amount of workers’ compensation fraud is
difficult. As for trying to measure its own effectiveness in
deterring fraud, in March 2004, during the course of our audit
work, the fraud division initiated the process of amending
an existing consultant contract to begin working on a set
The failure of the fraud of metrics to measure the effect of its antifraud efforts and
division to conduct the refine its business plan. However, at the time of our review the
research necessary to fraud division and its consultant had not yet developed the
identify the value of the performance measures for us to evaluate them or comment on
workers’ compensation their potential effectiveness. The failure of the fraud division
antifraud program it to conduct the research necessary to identify the value of
administers deprives the workers’ compensation antifraud program it administers
the fraud division of deprives the fraud division of information it needs to plan
information it needs to and evaluate its operations and leaves it without the means to
plan and evaluate its demonstrate its worth in reducing workers’ compensation fraud.
operations and leaves
it without the means to The fraud division also does not report information required
demonstrate its worth by law, including estimates of the economic value of insurance
in reducing workers’ fraud by type of fraud and recommendations of ways to reduce
compensation fraud. insurance fraud. When the fraud division fails to report all the
data elements the law requires, the Legislature, governor, and
fraud commission are not provided with the information they
need to make well-informed decisions regarding the proper
amount and use of the workers’ compensation fraud assessment.
The annual workers’ compensation antifraud program reports
(program reports) the fraud division produces to inform the
Legislature and fraud commission on the progress of the antifraud
program do not provide required information regarding the
antifraud program’s expenditures, search warrants issued, and
number of parties involved in fraud arrests and prosecutions.
Although by law the program reports must contain the funding
the fraud division received and a detailed breakdown of how
it used the funds, the fraud division ignores these and other
requirements and largely limits its reports to the allocations made
to the district attorneys, the number of arrests and prosecutions,
and the number of convictions and the names of those convicted.
Table 1 shows the items the fraud division is required to report
and whether it complied with that requirement in fiscal years
2000–01 and 2001–02.
6666 California State Auditor Report 2002-018 California State Auditor Report 2002-018 6677
TABLE 1
Requirements for Reporting by the Fraud Division
to the Legislature and Fraud Commission
Compliance for
Reporting Requirement Fiscal Years 2000–01 and 2001–02
All allocations, distributions, and expenditures of funds Partially
Number of search warrants issued No
Number of arrests and prosecutions, and the aggregate number of
parties involved in each Partially
Number of convictions and the names of all convicted
fraud perpetrators Yes
Estimated value of all assets frozen, penalties assessed, and restitutions
made for each conviction Partially
Any additional items necessary to fully inform the fraud commission and
the Legislature of the fraud-fighting efforts financed through this section Partially
Sources: Insurance Code and fraud division Program Reports for fiscal years 2000–01 and 2001–02.
Moreover, the fraud division did not ensure that the information
it contributed to the insurance commissioner’s annual reports
to the governor was complete in 2001 and 2002. As shown in
Table 2 on the following page, it did not report on seven of
10 categories specifically required during both years. In fact,
the fraud division fully reported only two of the 10 mandated
categories of information in 2001, and just one in 2002.
A LARGE PERCENTAGE OF THE FRAUD DIVISION’S
REFERRALS DO NOT RESULT IN PROSECUTIONS
From our review of the fraud division’s case management
We found that 87 percent database, it appears that the fraud division could more
of the workers’ effectively manage its investigative efforts. For example, as
compensation referrals shown in Figure 7 on page 69, we found that 87 percent of the
the fraud division received workers’ compensation referrals the fraud division received
between September 2001 between September 2001 and December 2003 were not
and December 2003 were submitted to district attorneys for prosecution. However, the
not submitted to district fraud division’s investigators did not charge time to all these
attorneys for prosecution. referrals. Of the 7,891 referrals1 it closed and did not submit to
district attorneys for prosecution, the fraud division spent time
1 Of these referrals, the fraud division closed and referred 641 to other entities for
investigation—479 to district attorneys and 162 to other entities—according to the
fraud division’s database.
6666 California State Auditor Report 2002-018 California State Auditor Report 2002-018 6677
TABLE 2
Requirements for Reporting by the Fraud Division
for the Insurance Commissioner’s Annual Report to the Governor
Fulfilled?
Reporting Requirement 2001 2002
Number of cases reported to the fraud division Yes Partially
Number of cases rejected for which an investigation was not initiated by the fraud division and the
reasons for not investigating them No No
Number of cases prosecuted in cooperation with other government licensing agencies governed by
the Business and Professions Code No No
Number of cases prosecuted as a result of the insurance commissioner’s assessment of funds from
insurers under Insurance Code, Section 1872.7, for the costs of administration and operation of the
fraud division No No
Estimate of the economic value of insurance fraud by type of insurance fraud Partially Partially
Recommendations of ways to reduce insurance fraud No No
Summary of activities in pursuing fraud reduction with the following parties: No No
• Insurance companies
• Department of Motor Vehicles
• California Highway Patrol
• Licensing agencies governed by the Business and Professions Code
• Department of Insurance
• Local and state law enforcement agencies
• Employers that are self-insured for workers’ compensation
Basic claims information, including trends of payments by type of claim and other claim information
generally provided in a closed-claim study No No
Summary of activities in pursuing a reduction in fraudulent denials and payments
of compensation No No
Number and types of cases investigated and prosecuted with workers’ compensation fraud
assessment funds Yes Yes
Sources: Insurance Code, 2001 Annual Report of the Insurance Commissioner, and the fraud division’s information submitted for
the 2002 Annual Report.
investigating 1,362. Similarly, the fraud division did not spend
time investigating all of its open cases and cases it submitted
to district attorneys for prosecution2. As shown in Figure 8 on
page 70, during the same period, fraud division investigators
spent more than 16 percent of their investigative hours on the
1,362 cases it closed and did not submit to the district attorneys.
Excluding open investigations that have yet to be submitted for
prosecution, fraud division investigators spent roughly one-
third of their recorded hours on the 1,362 cases that were closed
and not submitted to district attorneys for prosecution and
two-thirds of their hours on the 232 cases that were submitted.
2 Fraud division investigators charged time to 634 of the 946 open cases and 232 of the
233 cases it submitted to district attorneys for prosecution.
6688 California State Auditor Report 2002-018 California State Auditor Report 2002-018 6699
FIGURE 7
Outcome of Referrals the Fraud Division Received
From September 2001 Through December 2003
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��������������������������
�������������������
Source: Fraud division’s case management database.
*Of the 233 referrals submitted for prosecution as of December 22, 2003, 28 were rejected
by district attorneys.
Therefore, it is reasonable to assume that nearly one-third
of the hours charged to the open investigations, or roughly
22,400 hours for the period we reviewed, will probably be
spent on cases that the fraud division will not submit to district
attorneys for prosecution.
Although its database indicates that the fraud division submitted
only 3 percent of its workers’ compensation fraud referrals for
prosecution, it did not look at this issue in more depth. Based on
the large portion of referrals that the fraud division reports are
closed because of insufficient evidence, it appears that the quality
of suspected fraud referrals the fraud division receives from
insurers is not high enough to allow for successful investigations.
Moreover, no objective listed in the fraud division’s business plan
addresses improving the quantity and quality of the evidence
the fraud division receives supporting insurers’ fraud referrals
or increasing the number of referrals it submits for prosecution.
In fact, one of its objectives—to increase the number of referrals
it receives by 10 percent—seems to be at odds with these
statistics. To further this objective, the Department of Insurance
promulgated new emergency regulations in September 2003
meant, in part, to increase the number of workers’ compensation
6688 California State Auditor Report 2002-018 California State Auditor Report 2002-018 6699
FIGURE 8
Outcome of Hours Fraud Division
Investigators Spent on All Referrals
From September 2001 Through December 2003
���������������
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����������������
������������������
������������ �����������
����������� �����
�����������
�����
Source: Fraud division’s case management database.
fraud referrals it receives by 10 percent over the prior three-year
average. However, according to the fraud division’s database, it
does not investigate or submit to district attorneys the majority of
the referrals it currently receives.
The assistant chief deputy Furthermore, the fraud division has not adequately monitored
commissioner stated and managed its referral and investigation caseloads to
that the fraud division determine its success in focusing on the stated priorities of the
emphasizes the insurance insurance commissioner and fraud division. The assistant chief
commissioner’s initiative of deputy commissioner stated that the fraud division emphasizes
focusing on high-impact the insurance commissioner’s initiative of focusing on high-
referrals—those suspected impact referrals—those suspected fraud cases that include
fraud cases that include multiple suspects, involve a medical provider or attorney, or
multiple suspects, involve result in large losses—through its referral prioritization system.
a medical provider or The assistant chief deputy commissioner stated that the
attorney, or result in large priorities are influenced by stakeholder input and are established
losses—through its referral with the intent of directing resources to high-impact cases
prioritization system. involving multiple suspects or a large number of victims that
will serve as a deterrent to future fraud.
7700 California State Auditor Report 2002-018 California State Auditor Report 2002-018 7711
According to the insurance commissioner, he approved the new
priorities and strategies for the workers’ compensation antifraud
program in April 2003. In response, the fraud division’s workers’
compensation bureau chief stated that the fraud division was
implementing a balanced caseload for its regional offices and
prosecuting agencies that includes high-impact referrals. Our
review of the fraud division’s case management database shows
that between September 2001 and December 2003 half of the cases
it submitted to district attorneys were considered high impact.
Specifically, of the 233 referrals the fraud division submitted to
district attorneys, 116 were high impact and 117 were not. Also,
investigators spent almost two-thirds of all the time charged during
this period on high-impact cases. However, because the fraud
division did not establish baselines for these types of fraud and set
targets for the number of high-impact cases it would submit for
prosecution, it cannot know whether these statistics align with the
insurance commissioner’s initiatives or not.
We reviewed the 3,000 high-impact referrals entered in the fraud
division’s case management database from September 2001
through December 2003 and determined how much time
fraud investigators spent on these referrals and how many of
the referrals were ultimately submitted to district attorneys or
closed without being submitted. As shown in Figure 9, of the
FIGURE 9
Outcome of High-Impact Referrals the Fraud Division Received
From September 2001 Through December 2003
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Source: Fraud division’s case management database.
7700 California State Auditor Report 2002-018 California State Auditor Report 2002-018 7711
high-impact referrals entered in the database, 2,500 (83 percent)
were closed without being submitted to district attorneys for
prosecution as opposed to 116 that were submitted. Of the
referrals submitted for prosecution, district attorneys rejected
10 for prosecution, leaving only 106 (4 percent) that were
submitted to district attorneys and filed for prosecution.
When we looked at the amount of time investigators spent
on high-impact cases, we found that the majority of time
was spent on referrals that had not been submitted to district
attorneys as of December 2003. Specifically, as shown in
Figure 10, 56 percent (49,255 hours) of investigators’ time was
spent on investigations that were still open, and 12 percent
(10,077 hours) was spent on referrals that were closed and not
submitted for prosecution. In contrast, investigators spent
32 percent of their time investigating high-impact referrals
that were submitted to district attorneys, of which 30 percent
(26,229 hours) was spent on investigations that were accepted
or still under consideration by district attorneys for prosecution,
and 2 percent (2,022 hours) was spent on referrals that the
district attorneys ultimately rejected for prosecution.
FIGURE 10
Outcome of Hours Fraud Division Investigators
Spent on High-Impact Referrals
From September 2001 Through December 2003
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Source: Fraud division’s case management database.
7722 California State Auditor Report 2002-018 California State Auditor Report 2002-018 7733
The fraud division closes the majority of the high-impact
referrals it receives without investigating them. When fraud
division supervisors review referrals, they review the information
on the referral form and other information to determine
whether to assign the referral to an investigator and give it a
priority level. When fraud division supervisors decide to close
a referral, they list a reason for not investigating it. We found
that investigators charged hours on only 872 of the 3,000 high-
impact referrals the fraud division received from September 2001
through December 2003, leaving 2,128 with no hours charged.
Of those, 86 are still open and 2,042 were closed without
assigning them to an investigator.
Furthermore, when we exclude high-impact referrals that the
fraud division did not assign to investigators, as shown in
Figure 11, more than half the 872 high-impact referrals assigned
to investigators were closed without being submitted to district
attorneys for prosecution. As a result, it is reasonable to assume
that half the open investigations, or about 149 cases during the
period we reviewed, will most likely not be submitted to district
attorneys for prosecution.
FIGURE 11
Outcome of High-Impact Referrals for Which
Fraud Division Investigators Charged Time
From September 2001 Through December 2003
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Source: Fraud division’s case management database.
7722 California State Auditor Report 2002-018 California State Auditor Report 2002-018 7733
The reason listed for closing the majority of the high-impact
referrals—at least 1,427 (70 percent) of the 2,042 referrals—was
insufficient evidence. According to the fraud division, insurers
are required to send only the basic information provided on
the division’s referral form, an example of which is shown in
Appendix B. If the supervisor reviewing the referral determines
that the referral has merit, the case will be assigned to an
investigator, and the fraud division will request to review the
insurer’s claim file.
The Fraud Division Has Not Defined Benchmarks or
Targets for Each Appropriate Activity and Used Them
to Measure Performance
Benchmarks or anticipated targets are indicators that could help
A benchmark or target in an assessment of the actual impact of the fraud division’s
provides a means for actions. A benchmark or target provides a means for making
making a quantified a quantified comparison between the actual result and the
comparison between the result intended or benchmarked. The comparisons can provide
actual result and the result important information for management to use in determining
intended or benchmarked. whether the fraud division’s antifraud program is operating as
However, the fraud intended and whether resources are being allocated appropriately.
division has set no However, the fraud division has set no meaningful benchmarks
meaningful benchmarks against which it could periodically measure its actions.
that it periodically
uses to measure its The fraud division has not come up with a way to measure the
actions against. return on investment regarding its investigative activities and
its success in fighting fraud. It currently reports to the fraud
commission on the number of fraud referral cases it opened,
the number prosecuted by district attorneys, the number of
arrests and convictions arising from these cases, and the related
dollar amounts of the fraud charged, as well as a description
of its outreach efforts. However, the fraud division has yet to
establish a target for how many investigations it plans to submit
to the county district attorneys per year and how many of
those investigations it expects district attorneys to successfully
prosecute each year so that it can measure the success or failure
of its investigative efforts funded by the fraud assessment. It
also has yet to measure the extent to which various types of
fraud occur in the workers’ compensation system and establish
baselines it can use to target both its own and the district
attorneys’ activities.
For example, if the fraud division were to project that medical
provider fraud contributes $50 million annually to the cost of
the workers’ compensation system, it could then set targets for the
7744 California State Auditor Report 2002-018 California State Auditor Report 2002-018 7755
annual number of provider fraud referrals it would investigate,
the annual number of those referrals it would submit to district
attorneys to prosecute, and the annual amount of chargeable
fraud that would result from successful prosecutions. These
targeted amounts could then be compared to the fraud division’s
and the district attorneys’ actual results for the year to measure
their success in meeting the targeted benchmarks. Further, in the
following year, if the fraud division again projected the amount
of provider fraud and found that the cost of this type of fraud
added $40 million to the system annually, it would provide
a strong indicator that the fraud assessment funds used in
fighting provider fraud were paying off.
As another example, the division could measure its return on
investment by setting a targeted return on the fraud assessment
funds invested in the program compared to the amount of
chargeable fraud taken out of the system based on successfully
prosecuted cases. As shown in Figure 12 on the following
page, we compared the aggregate workers’ compensation fraud
assessment for the last three fiscal years to the amount of
chargeable fraud that district attorneys reported to the fraud
division. We found that the actual ratios of assessment funds
spent compared with the dollar value of fraud charged for
fiscal years 2001–02 and 2002–03 are 1.6 and 1.8, respectively.
Therefore, the fraud division could set the targeted ratio for
fiscal year 2004–05 at 3.0, which, if reached, would result in
prosecutions of $3 of chargeable fraud for every fraud assessment
dollar spent on the program.
Although the amount of chargeable fraud shown in Figure 12
might be skewed in any given year because the fraudulent
activities could have occurred in prior years and investigations
and prosecutions of those activities might span more than the
current year being reported, it is one example of how the fraud
division could develop some measurements of the return on
investment for the workers’ compensation antifraud program
that the fraud commission could use in determining aggregate
funding levels and the fraud division could use in measuring
its own effectiveness. Other measurements could be developed
using the annual fraud assessment funds invested compared
with the annual restitution ordered by the court and the
amounts actually collected.
The fraud division measures its and the district attorneys’
effectiveness by focusing on statistics involving the number of
arrests, number of convictions, amount of chargeable fraud,
7744 California State Auditor Report 2002-018 California State Auditor Report 2002-018 7755
FIGURE 12
Total Funding for the Workers’ Compensation Antifraud
Program and Chargeable Fraud Detected for
Fiscal Years 2000–01 Through 2002–03
Source: Program reports submitted to the fraud division by county district attorneys.
number of cases opened, number of cases prosecuted, and
other activity levels in developing performance metrics for its
own and the district attorneys’ activities. However, the fraud
division and district attorneys might be able to influence some
of this kind of data. For example, in April 2002 the division
chief sent out memorandums to each regional office instructing
them to spend more fraud assessment funds and concentrate on
wrapping up cases and forwarding them to district attorneys by
the end of the year to ward off criticism that the division does
not adequately investigate workers’ compensation fraud cases.
Also, as discussed in Chapter 1, the process of awarding grants does
not include a method to decide the most effective distribution of
grant funds in part by matching district attorneys’ performance
against the objectives included in their respective applications. The
current decisions regarding the size of these grants are based largely
on a variety of statistics regarding actions taken by district attorneys
that are provided without any context as to whether those numbers
represent success in achieving the objectives set forth in the district
attorneys’ applications.
7766 California State Auditor Report 2002-018 California State Auditor Report 2002-018 7777
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In April 2002, the
division chief sent out
memorandums to each
regional office instructing
them to spend more fraud
assessment funds and
concentrate on wrapping
up cases and forwarding
them to district attorneys
by the end of the year to
ward off criticism that
the division does not
adequately investigate
workers’ compensation
fraud cases.
THE DIVISION DOES NOT ADEQUATELY MONITOR THE
USE OF FRAUD ASSESSMENT FUNDS AWARDED TO
DISTRICT ATTORNEYS
The Department of Insurance undertakes two efforts to
monitor the use of fraud assessment funds. However, neither
is adequate to ensure that the county district attorneys comply
with the terms they agreed to when they submitted their grant
applications. Department of Insurance regulations require that
each county submit an annual independent audit certifying
that the county district attorney’s expenditures complied with
the laws, regulations, request for application guidelines, and the
county plan. Although the request for application guidelines
include audit procedures that must be addressed in these annual
audits, all but one of the audits we reviewed failed to adhere to
these procedures.
Additionally, the Ethics and Operational Compliance Office
(audit unit) within the Department of Insurance reviews
county district attorneys’ use of workers’ compensation fraud
assessment funds. Although the audit unit has reported
numerous findings and has recommended that county
district attorneys return more than $100,000 in questionable
expenditures, it has reviewed only 13 of the 37 county district
attorneys who received grant funding in the last two years.
Therefore, the audit unit, too, is not providing the audit
coverage required to adequately ensure that all county district
attorneys complied with the terms they agreed to in their
applications for the funds.
In the Audit Reports They Submit Annually, District Attorneys
Do Not Provide Adequate Assurance That They Used Fraud
Assessment Funds Properly
Department of Insurance regulations require that each county
district attorney submit an annual independent audit to the
fraud division certifying that the district attorney’s expenditures
complied with state laws, Department of Insurance regulations,
request for application guidelines, and the county plan. The
guidelines in the request for application require the review of
the internal control system as it applies to the district attorney’s
workers’ compensation antifraud program and lists 14 audit
procedures that must be followed during the annual audit.
Among the procedures called for are those shown in the text box on
the following page. However, all but one of the audits we reviewed
failed to adhere to these requirements. In fact, 26 of 27 audits we
reviewed did not include the required certification, nor did
7766 California State Auditor Report 2002-018 California State Auditor Report 2002-018 7777
they comment on the internal control system as
it applied to the workers’ compensation antifraud
Some Audit Requirements Specifi ed in
the Request for Application Guidelines program. Moreover, these reports did not provide
an opinion on the district attorneys’ compliance
• Determine that expenses charged to the with laws, regulations, contracts, and grant
antifraud program are limited to personnel
provisions. Rather, they performed certain tests
funded by the grant.
to obtain reasonable assurance that the fi nancial
• Determine that direct charges to the
program are not included in indirect costs statements were free of material misstatement.
also charged to the program. We do not believe audits such as these meet the
• Determine that equipment purchased with criteria stated in the law and the grant application
funds from the fraud assessment grant is in
guidelines. Furthermore, one county district
the custody and use of the personnel funded
by the grant. attorney in our sample had yet to submit an audit
report for fi scal year 2001–02 as of February 2004,
• Identify costs that are questioned or
disallowed for the grant period because of 15 months after the deadline.
noncompliance.
• Certify in the report that county expenditures The requirements for audits in the district
were made for the purposes of the program
attorneys’ workers’ compensation antifraud
as specifi ed by law, Department of Insurance
regulations, the guidelines in the request for program are similar to those for the compliance
application, and the county plan.
audits required by the federal government for grant
funds it provides to state and local governments.
The federal government requires that auditors test
transactions and perform other audit procedures necessary to
support an opinion on compliance to be included in the audit
report. We believe an adequate audit of county expenditures
could rely on a sample of transactions and other procedures
similar to the federal government’s requirements to offer an
opinion on the level of compliance for each county.
In contrast, the annual audits of county district attorneys appear
to focus mainly on the fairness of the fi nancial statements.
Many contain standard language giving negative assurance that
nothing came to the auditors’ attention that would lead them to
conclude that the district attorney was in violation of the law or
regulations. This sort of review does not give the fraud division
assurance that the expenditures of antifraud program funds were
in compliance with the program described by the county district
attorney in the application for grant funds. Therefore, the fraud
commission and the fraud division cannot rely on these audits
to verify whether the county district attorney followed the
antifraud program he or she agreed to implement as part of
the grant application.
According to the fraud division’s workers’ compensation bureau
chief, the fraud division has not required that the annual audit
reports contain the required certifi cation because the county
auditors preparing the audit reports usually do include general
7788 California State Auditor Report 2002-018 California State Auditor Report 2002-018 7799
language stating that the funds from the fraud assessment are being
used appropriately by the county district attorneys, which appears
to satisfy the requirement for the fraud division staff. Nevertheless,
in the audit reports we reviewed, we found no positive assurance
that fraud assessment funds were being used appropriately.
Department of Insurance Audits Provide Limited Assurance
That District Attorneys Properly Use Fraud Assessment Funds
The audit unit voluntarily performs audits of county district
attorneys’ use of fraud assessment funds. Although the audit
unit is not statutorily required to audit grants of workers’
compensation fraud assessment funds, it is required to review
county district attorneys’ compliance with the grants for
Department of Insurance other antifraud programs, such as the one for auto insurance.
audits of county district During those audits, audit unit staff also look at how the
attorneys’ use of workers’ district attorneys charge time and expenses to grants for the
compensation fraud workers’ compensation antifraud program and whether they
assessment grants violate any of the grant requirements. The audit unit reviews
give a thorough and expenditures to determine whether the district attorneys use
documented indication of the grants of fraud assessment funds in accordance with the
their compliance with the law, Department of Insurance regulations, and the guidelines in
requirements of the grants. the application submitted for the funds. We reviewed the work
However, the audit unit has papers supporting these audits and believe they give a thorough
only completed a limited and documented indication of the county district attorneys’
number of these audits. compliance with the requirements of the grants of workers’
compensation assessment funds. However, the audit unit has
completed only a limited number of these audits.
During the last two years, the audit unit has reviewed 13 of the
more than 30 county district attorneys that receive workers’
compensation fraud assessment grants, reported 38 findings,
and recommended that these district attorneys return $103,400
in grant funds because of questionable expenditures. County
district attorneys have returned $55,300, or 53 percent, and
the Department of Insurance sent out collection letters for the
remaining $48,100 at the end of February 2004.
Although its audits are effective and result in the detection
and recovery of questionable expenditures, the audit unit’s
coverage of district attorneys is limited because it does not
have sufficient staff to audit all district attorneys that receive
workers’ compensation fraud assessment grants on a regular
basis. In fact, the audit unit has not recently reviewed 22 of
the 34 county district attorneys that received fraud assessment
funds in fiscal year 2002–03, and reviews of the five county
7788 California State Auditor Report 2002-018 California State Auditor Report 2002-018 7799
district attorneys receiving the largest amounts of grant
funds have not been conducted since 1998. Further, although
the chief of the audit unit told us he does not plan to stop
If the fraud division auditing any of these programs, he said he places county
required the county district attorneys who receive only workers’ compensation
district attorneys to grant funds at the bottom of the audit plan, as he receives no
submit audit reports from funding to conduct these audits. However, if the fraud division
their independent auditors required the county district attorneys to submit audit reports
that met the requirements from their independent auditors that met the requirements
in the Department of in the Department of Insurance regulations and fraud grant
Insurance regulations and application guidelines and included an opinion on compliance,
fraud grant application the audits performed by the audit unit would not be necessary.
guidelines and included
an opinion on compliance,
the audits performed by
RECOMMENDATIONS
the audit unit would not
be necessary. To ensure that it fulfills all aspects of its role in the workers’
compensation antifraud program, the fraud division should take
the following steps:
• Recognize its responsibilities beyond investigating fraud,
including using documented past performance and future
projections to advise the fraud commission and the insurance
commissioner on the optimum annual amount of aggregate
assessment needed by the program to fight workers’
compensation fraud and the most effective distribution of
the funds assessed to investigate and prosecute workers’
compensation fraud, and reporting on the economic value of
insurance fraud and making recommendations to reduce it.
• Modify its business plan to meet noninvestigative
responsibilities, including establishing appropriate goals and
objectives, activities, and priorities.
• Establish benchmarks to measure its and the district attorneys’
performance in meeting goals and objectives and to
determine whether the program is operating as intended and
resources are appropriately allocated.
• To meet its noninvestigative responsibilities, the fraud
division should realign its resources to enable it to conduct
the research necessary to fulfill its statutory role as an advisor
regarding the level of funding and the direction of fraud
reduction efforts. The research should include measuring
the nature and extent of fraud in the workers’ compensation
8800 California State Auditor Report 2002-018 California State Auditor Report 2002-018 8811
system and the effect of antifraud efforts and monitoring the
performance of county district attorneys who receive grants of
fraud assessment funds.
• Reevaluate the process it has established for insurers and other
state entities involved in employment-related activities to
report suspected fraud. The fraud division should identify the
type of referrals and level of evidence it requires to reduce
the number of hours it spends on referrals that it ultimately
does not pass on to county district attorneys for prosecution.
To justify the use of fraud assessment funds, the fraud commission
and the insurance commissioner should require the fraud
division to conduct a return-on-investment analysis for the
workers’ compensation antifraud program as a whole and to
annually report the results to the fraud commission and the
insurance commissioner.
To improve the level of assurance contained in the independent
audit reports submitted by county district attorneys regarding
fraud assessment funds being spent for only program purposes,
the fraud division should do the following:
• Clarify its expectations for the independent audits by seeking
a change in the Department of Insurance regulations that
would require audit reports to provide an opinion on county
district attorneys’ level of compliance with key provisions
of the applicable laws, regulations, and terms of the fraud
assessment grants.
• Ensure that county district attorneys comply with the
independent audit requirements and promptly submit their
audit reports. n
8800 California State Auditor Report 2002-018 California State Auditor Report 2002-018 8811
Blank page inserted for reproduction purposes only.
8822 California State Auditor Report 2002-018 California State Auditor Report 2002-018 8833
CHAPTER 3
Efforts to Detect and Prevent
Workers’ Compensation Fraud Are
Inadequate and Lack Cooperation
Between Agencies
CHAPTER SUMMARY
Improvement is needed in efforts to detect and report
suspected fraud to the Department of Insurance’s Fraud
Division (fraud division). Although the law requires insurers
to maintain units to detect fraud and report it to the fraud
division, insurers vary greatly in the number of suspected
fraud cases they report. The insurance commissioner stated that
the lack of a uniform methodology and standards are one reason
that insurers are not following through in their responsibility to
fight fraud. However, the State Compensation Insurance Fund
(State Fund) states that concerns about civil litigation affect the
manner in which it refers suspected fraud to the fraud division.
The Department of Insurance’s recent efforts to redefine
regulations to clarify reporting standards and the actions it plans
to take to increase referrals do not appear to adequately address
the State Fund’s concerns about reporting suspected fraud to the
fraud division. Moreover, insurers apparently are not providing
the fraud division with many referrals concerning the types of
fraud that the insurance commissioner considers high impact
and therefore high priority for investigation.
The fraud division does not adequately review insurers’ special
investigative units and their efforts to detect and report suspected
fraud to ensure that they comply with the law, nor does it inform
insurers of the type and quality of referrals it needs to efficiently
meet its responsibilities. It also fails to review a significant
number of the insurers it is authorized to audit and does not have
adequate standards and procedures in place to conduct its audits.
In addition, the fraud division does not adequately track findings
from its reviews of insurers’ special investigative units and has not
established effective practices to encourage adherence with the
law to detect and report suspected workers’ compensation fraud.
Increased cooperation and information sharing is needed among
agencies that accumulate data that could help reduce workers’
compensation fraud. A division within the Department of Industrial
8822 California State Auditor Report 2002-018 California State Auditor Report 2002-018 8833
Relations (Industrial Relations) performs reviews to determine
whether employers comply with certain labor law requirements,
including whether they have secured workers’ compensation
insurance for their injured employees. Even though these reviews
could be useful in detecting insurance fraud and unlawfully
uninsured employers, the division in Industrial Relations does not
share the results of its reviews with the fraud division.
Industrial Relations also has not implemented three legislatively
mandated programs designed to detect unlawfully uninsured
employers, provide a protocol for reporting suspected fraud,
and warn program participants against committing workers’
compensation fraud. The result of implementing these provisions
would be useful to the fraud division’s antifraud efforts.
Finally, the formula Industrial Relations uses to compute and
collect fraud assessment surcharges from the State’s employers
is flawed. Industrial Relations is responsible for collecting and
depositing the surcharges in the fraud account in the Insurance
Fund that the fraud division uses to pay for its antifraud activities
and that funds grants awarded to district attorneys to fight
workers’ compensation fraud. However, the formula Industrial
Relations uses overcharges the State’s insured employers.
Moreover, Industrial Relations has not implemented procedures
that would ensure that insurers remit the correct amount of the
fraud assessment surcharge.
IMPROVEMENT IS NEEDED IN REPORTING POTENTIAL
FRAUD TO THE FRAUD DIVISION
The fraud division receives referrals of suspected fraud primarily
from insurers, but it has not adequately worked with insurers
to define the level of evidence it needs to further investigate
the referrals. The actions that the fraud division and the
Department of Insurance plan to take, including redefining
the regulations governing insurers’ review of claims and
reporting of suspected fraud—functions usually performed
by insurers’ special investigative units—do not address the
current barriers to achieving better reporting of suspected fraud.
Although the numbers of suspected fraud referrals the special
investigative units report vary greatly, the audits the fraud
division has performed do not represent a significant portion of
the workers’ compensation market, fail to ensure that the special
investigative units comply with the law and are poorly finalized,
tracked, and enforced.
8844 California State Auditor Report 2002-018 California State Auditor Report 2002-018 8855
Insurer Compliance With Requirements to Detect and Report
Suspected Workers’ Compensation Fraud Varies
Despite a requirement that insurers investigate suspected fraud
and refer to the fraud division claims that show reasonable
Despite a requirement evidence of fraud, insurers vary significantly in the number of
that insurers investigate fraud referrals they submit. Insurance Code, Section 1875.20,
suspected fraud and states that every insurer must maintain a unit to investigate
refer to the fraud possible fraudulent claims, and Section 1872.4(a) requires an
division claims that show insurer to submit a referral to the fraud division within 60 days
reasonable evidence after determining that a claim appears to be fraudulent.
of fraud, insurers vary
significantly in the As shown in Figure 13, among insurers earning workers’
number of fraud referrals compensation premiums exceeding $40 million per year, some
they submit. appear to be underreporting suspected workers’ compensation
fraud while others appear to be regularly referring suspected
fraudulent claims. For our analysis, we measured the referral rate by
obtaining data on the number of referrals from the fraud division
and calculating the referrals per $1 million in earned premiums for
all insurers earning more than $40 million annually in workers’
FIGURE 13
Referral Rate of Insurers Earning More Than
$40 Million in Annual Premiums During 2001 and 2002
Sources: Department of Insurance Web site and the fraud division’s case management database.
8844 California State Auditor Report 2002-018 California State Auditor Report 2002-018 8855
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compensation premiums in California during both 2001 and 2002.
As shown, five of the 23 companies in this group referred more
than one claim per $1 million in earned premiums in at least one
of the two years. It appears that some of the remaining 18 insurers
may be failing to fulfill their responsibilities to refer suspected fraud,
including a few insurers that did not submit a single referral in a
given year.
Using the same method of calculating referral rates, we also found
that the five insurers reporting the highest earned premiums for
2000 through 2002 referred suspected claims at a much lower rate
than those reporting lower levels of earned premiums. As shown
in Figure 14, the referral rate for the top five insurers in 2002 was
0.03, or less than one suspected fraudulent claim per $20 million in
earned premiums. All other workers’ compensation insurers earning
more than $40 million in premiums in 2002 had a referral rate
of 0.40, which translates to eight claims per $20 million in
earned premiums. The referral rates were significantly lower for
the top five companies in 2000 and 2001 as well.
FIGURE 14
Referral Rates for Workers’ Compensation Insurers by
Earned Premium for 2000 Through 2002
Sources: Department of Insurance Web site and the fraud division’s case
management database.
8866 California State Auditor Report 2002-018 California State Auditor Report 2002-018 8877
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Barriers Exist That Prevent Insurers From Consistently
Referring Suspected Fraud
The insurance commissioner and the fraud division cite
several factors they believe are likely getting in the way of
insurers reporting suspected fraud as required. The insurance
commissioner stated that the lack of a uniform methodology
and standards for assessing and reporting suspected fraud is one
reason that some insurers may be derelict in their responsibility
to fight fraud. When we asked the chief of the fraud division
about the problems that insurers have with reporting suspected
fraud cases, he stated that past regulations poorly defined when
insurers should refer suspected fraud to the fraud division.
The insurance commissioner also stated that the quality and
quantity of referrals from insurers are key problems and are the
primary reason for adopting revised emergency regulations.
According to the assistant chief deputy commissioner, the
Department of Insurance is increasing its efforts to monitor
insurers’ investigative units, including developing a new audit
methodology and working with the insurance industry to
permanently amend the regulations to better define when
suspected fraud is reportable. She stated that temporary
emergency regulations are already in effect until May 2004 for
that purpose. The assistant chief deputy commissioner also
stated that the Department of Insurance plans to refine the
operations of the fraud division’s special investigative audit unit
to increase its audit coverage and then seek additional staff.
The law states that to refer a case of suspected fraud, an
insurer must have a “reasonable belief” the fraud actually
State Fund believes occurred. However, the State Fund believes that civil liability
there is civil liability is associated with referring suspected fraud cases. According
associated with referring to the State Fund’s special investigative unit manager, the
suspected fraud cases. courts have interpreted a reported suspected fraudulent claim
According to State Fund’s to be equivalent to an accusation and therefore subject to
special investigative unit a malicious prosecution claim. However, she believes she
manager, the courts have protects her organization by having in place the facts needed
interpreted a reported to defend the State Fund against any potential lawsuit. The
suspected fraudulent claim special investigative unit manager stated that she focuses on
to be equivalent to an the definition of fraud—in particular, the elements of the crime,
accusation, and therefore which she describes as a lie, knowledge, intent, and materiality.
subject to a malicious Once her investigators are able to substantiate these four things,
prosecution claim. she believes the State Fund can then assert, in good faith, that
its investigators have a reasonable belief of suspected fraud that
requires the State Fund to report the case to the fraud division
and district attorneys. Without these four elements, the special
8866 California State Auditor Report 2002-018 California State Auditor Report 2002-018 8877
investigative unit manager believes she would have a difficult
time proving in court that her special investigators acted with
reasonable belief.
Given the fraud division’s limited resources for investigating
referrals and the large number of referrals it closes for lack of
evidence, it seems reasonable that the fraud division would
benefit from working with insurers to help them understand the
level of evidence needed to successfully investigate a referral and
submit it for prosecution. According to the special investigative
unit manager for the State Fund, rather than sending a suspected
fraud referral to the fraud division using only the required
referral form, the State Fund sends documented referrals that are
prepared according to the documented referral protocol of the
California District Attorneys Association and the Department of
Insurance. The referrals include substantiating evidence along
with the referral form. The special investigative unit manager
indicated that her unit submits the evidence along with
its referrals because documented referrals are more likely to be
investigated by the district attorneys or the fraud division. She
noted that in many instances, if a special investigative unit makes
a referral using only the required referral form, the referrals are
not investigated because there is not enough information to get
a clear picture of the case and to generate interest in pursing the
investigation. She also stated that submitting unsubstantiated
allegations is a waste of time for the insurers’ special investigative
units, the district attorneys, and the fraud division.
As a result of these two differing opinions of the problems with
the current suspected fraud referral process, and given that the
According to our review fraud division is not adequately monitoring insurers, we believe
of its database of fraud the actions the Department of Insurance and fraud division have
referrals, the fraud taken or plan to take, such as adopting emergency regulations, will
division received almost not adequately address the State Fund’s concerns about reporting
two-thirds of its referrals suspected fraud, including the level of evidence provided by
from insurers, 89 percent insurers with referrals that the fraud division expects to further
of these referrals were for investigate. For example, the emergency regulations define
claimant fraud, which suspected fraud that requires reporting as a case in which “facts
do not appear to be the and circumstances create a reasonable belief that a person or entity
high-impact referrals the may have committed or is committing insurance fraud.” However,
insurance commissioner the Insurance Code already requires insurers to report any case
has identified as a involving what they reasonably believe is fraudulent activity.
priority for the
workers’ compensation Likewise, insurers apparently are not reporting the types of
antifraud program. suspected fraud the insurance commissioner has designated
as high-impact and the fraud division has made a priority to
investigate. According to our review of its database of fraud
8888 California State Auditor Report 2002-018 California State Auditor Report 2002-018 8899
referrals, although the fraud division received almost two-thirds
of its referrals from insurers, 89 percent of those referrals were
for claimant fraud, which does not appear to be among the
high-impact types of fraud the insurance commissioner has
identified as a priority for the workers’ compensation antifraud
program. Figure 15 shows the types of suspected fraud referrals
insurers reported from September 2001 through December 2003.
During that period, the fraud division spent more than 13,000
hours investigating cases referred by insurers that it ultimately
closed without referring to district attorneys for prosecution.
FIGURE 15
Types of Suspected Fraud Referrals Insurers Reported
From September 2001 Through December 2003
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Source: Fraud division’s case management database.
The Fraud Division Lacks an Adequate Strategy for Its Special
Investigative Audit Unit
The fraud division has made some internally weak efforts to review
insurers’ compliance with the legal requirement to detect and
refer suspected fraud. The fraud division’s special investigative
audit unit performs reviews of insurers to determine whether
they comply with fraud reporting requirements. However, a
lack of strategic planning has left the special investigative audit
8888 California State Auditor Report 2002-018 California State Auditor Report 2002-018 8899
unit without a program that effectively targets insurers to achieve
maximum compliance with reporting requirements, and it has not
developed a standardized auditing approach that would ensure
that its reviews are sufficient to determine insurers’ compliance
with the law. Further, the special investigative audit unit does not
promptly prepare reports and follow up on audit findings. Finally,
the Department of Insurance has not established effective penalties
to promote insurers’ compliance.
Audit Efforts Have Not Provided Adequate Coverage of Insurers
The special investigative audit unit has not achieved the
most effective audit coverage of the community of workers’
compensation insurers. For example, the workers’ compensation
insurers that the special investigative audit unit reviewed during
the past two years do not represent a significant portion of the
market. As was shown in Figure 14 on page 86, the rate of referrals
of suspected fraud per million dollars of earned premiums for
the largest insurers is lower than for insurers with less market
share. However, the fraud division focused 59 percent of its audits
on insurers that represent less than 0.5 percent of the market.
In addition, the special investigative audit unit chose not to
review 43 percent of the insurers selling workers’ compensation in
the State because they do not have offices in California. According
The special investigative to the manager of the special investigative audit unit, from the
audit unit excluded remaining insurers that maintained offices in California, the
43 percent of the special investigative audit unit selected insurers for review based
insurers selling workers’ on information contained in their annual reports. According
compensation in the to the chief investigator who oversees the special investigative
State from review audit unit, the fraud division did not feel it could develop any
because they do not have type of schedule for regular insurer reviews until it had reviewed
offices in California. all or most insurers. He stated that one reason for attempting to
review all or most insurers is that insurers had complained about
the special investigative audit unit’s past practices of auditing
only certain insurers while other insurers were not reviewed.
He speculated that once the special investigative audit unit had
reviewed the majority of insurers, the results of those reviews
would indicate the need for a regular review schedule.
Furthermore, the special investigative audit unit reviews an
average of only 14.5 (8 percent) of the 175 insurers in the fraud
division’s workers’ compensation database each year. This
number is not sufficient to determine whether the community
of workers’ compensation insurers is adequately complying
with fraud-reporting requirements. According to the insurance
9900 California State Auditor Report 2002-018 California State Auditor Report 2002-018 9911
commissioner, the special investigative audit unit has not
performed more audits of workers’ compensation insurers
during the past two years because of inadequate staffing levels
and travel restrictions. The insurance commissioner stated
that although the Department of Insurance is supported
exclusively by special fund revenues, the State’s budget policy
has not permitted growth but instead has mandated spending
authority and personnel year reductions. In fact, he stated that
departmentwide, 30 positions and $1.8 million in spending
authority were eliminated in fiscal year 2001–02; in fiscal year
2002–03 the department lost an additional 31 positions and
$1.2 million. Moreover, the insurance commissioner told us that
proposals for any program enhancements, regardless of funding
source, were strongly discouraged by the Department of Finance.
Finally, the insurance commissioner stated that because the
special investigative audit unit is also responsible for auditing
insurers selling other lines of insurance it cannot focus its
resources exclusively on workers’ compensation audits.
Nevertheless, time reports for 2003 provided by the manager
of the special investigative audit unit show that the four staff
members comprising the unit spent from 23 percent to 45 percent
of their time working on projects other than special investigative
unit reviews. Our review of time-reporting documents and
inquiries indicates that staff also spend time on activities that,
according to the manager of the special investigative audit unit,
included aiding insurers in implementing the electronic suspected
fraud referral program, answering technical calls from electronic
referral users, and occasionally providing backup for reception
Without standards and database input.
for audit objectives,
audit procedures, and
The Special Investigative Audit Unit Lacks Standards in Its
supervision of the audits,
Approach to Auditing Insurers
the fraud division cannot
be certain that the special The special investigative audit unit has not established procedures
investigative audit unit is that include standards for auditing insurers’ special investigative
helping insurers provide units. Without such standards for audit objectives and procedures,
referrals of the quality that methods for sampling claims transactions, audit evidence, and
the fraud division needs to supervision of the audits, the fraud division cannot be certain
effectively and efficiently that the special investigative audit unit is helping insurers provide
investigate workers’ referrals of the quality that the fraud division needs to effectively
compensation fraud. and efficiently investigate workers’ compensation fraud.
According to the manager of the special investigative audit
unit, determining what audit procedures are being used would
demand interviewing each reviewer to determine his or her
method for conducting a review. Not surprisingly, the reviews
9900 California State Auditor Report 2002-018 California State Auditor Report 2002-018 9911
we examined reflected disparate approaches. Moreover, seven of
the 10 audits we reviewed relied heavily on interviews and self-
reporting by insurers, were lacking in documentary evidence,
and did not adequately test claims for insurers’ compliance with
required procedures for handling potentially fraudulent claims.
For example, according to one reviewer in the special investigative
audit unit, one audit procedure that reviewers should perform
is determining whether insurers accurately report suspected
fraud cases to the fraud division. However, we noted that the
Of the 10 reviews we reviewer accepted a verbal assurance from the insurer that it
examined, we found had sent the number of referrals that the fraud division had in
only four in which the its database, rather than verifying that all suspected cases of
reviewers sampled claims fraud resulted in reported referrals. According to the manager
and in two of those cases of the special investigative audit unit, it did not have a policy
the reviewer allowed to select actual claims for testing until the summer of 2003, and
the insurer to select the it is still not a written policy. Moreover, of the 10 reviews we
claims for review. examined, we found only four in which the reviewers sampled
claims to search for unreported indicators of fraud, and in
two of those cases, the reviewer allowed the insurer to select
the claims for review. Finally, the reviewers did not accurately
document determinations as to why they found an insurer to be
in compliance with fraud-reporting requirements.
According to the chief investigator who oversees the special
investigative audit unit, the fraud division is preparing a
manual of procedures for conducting reviews, and it has already
implemented a policy to use a standard random sampling
methodology with a minimum sample of 30 claims per audit to
review for unreported suspected fraudulent claims. The manager
stated that the procedures manual will cover how to select
insurers for review and procedures for preliminary auditing
activities, fieldwork, reporting, and supervisor review. According
to the manager of the special investigative audit unit, the
manual will represent the procedures the special investigative
audit unit currently has in place. However, we found in our
review that the procedures actually practiced by the staff of the
special investigative audit unit do not reflect the procedures the
manager described as currently being in place.
The Special Investigative Audit Unit Does Not Promptly Finalize
Its Reports or Track and Enforce Audit Findings
For five of the seven audits of insurers with findings that we
reviewed, the special investigative audit unit had not sent letters
to the insurers outlining the findings, even though between one
9922 California State Auditor Report 2002-018 California State Auditor Report 2002-018 9933
and three months had passed since the review was completed. The
letters, which discussed reviews performed from October through
November 2003, were waiting for manager review. According to the
manager of the special investigative audit unit, she was working on
other fraud division priorities, such as new emergency regulations
pertaining to the requirements to report fraud and arranging and
attending meetings with the insurance industry.
The special investigative audit unit also does not adequately
track its audit findings to follow up on corrective action by
insurers. According to the chief investigator who oversees the
special investigative audit unit, tracking these findings is left
up to the individual analysts who perform the audits. The chief
investigator stated that the special investigative audit unit would
like to enhance the internal tracking of findings and other
comprehensive information regarding insurers through the
creation of an internal database, but that this is not a top priority.
Moreover, the fraud division has not established effective
Although the law states penalties to promote compliance with the requirement that
that any insurer failing insurers maintain a special investigative unit. Although the law
to comply with fraud- states that any insurer failing to comply with fraud-reporting
reporting provisions will provisions will be subject to a maximum fine of $55,000 and/or
be subject to a maximum suspension of the insurer’s certificate of authority to conduct
fine of $55,000 and/ business in the State, the insurance commissioner feels that
or suspension of the these two tools are relatively ineffective because they represent
insurer’s certificate of two extremes of regulatory enforcement. He stated that
authority to conduct although suspension of a company’s authority to sell insurance
business in the State, the may be an appropriate penalty for the most egregious violations,
insurance commissioner special investigative unit violations tend to be technical in
feels that these two nature and do not rise to this level. At the other extreme, the
tools are relatively insurance commissioner believes that the $55,000 fine is easily
ineffective because they paid by insurers and does not constitute an effective deterrent
represent two extremes of for noncompliance. The insurance commissioner stated that
regulatory enforcement. financial penalties have been levied in the past, but license
suspension has not been used for the reason just described.
Based on the special investigative audit unit’s own reviews,
insurers are not complying with the requirements in law related
to special investigative units. The reviews we examined show
an average of 1.7 findings per insurer. Out of our sample of 10,
one insurer did not meet the statutory standards of maintaining
a fraud-reporting function, and four had failed to make any
referrals of suspected fraud to the fraud division as called for by
the law.
9922 California State Auditor Report 2002-018 California State Auditor Report 2002-018 9933
IMROVEMENT IS NEEDED IN SHARING INFORMATION
BEWEEN STATE DEPARTMENTS TO IDENTIFY
POTENTIAL WORKERS’ COMPENSATION FRAUD
The Department of Industrial Relations’ Division of Labor
Standards Enforcement (DLSE) does not share the results of
its field reviews of employers with the fraud division. An
August 2001 report on the workers’ compensation antifraud
program by the Commission on Health and Safety and Workers’
Compensation stated that greater interagency coordination
among those entities charged with combating workers’
compensation fraud would increase the likelihood of detection,
investigation, and successful prosecution of major fraudulent
schemes. Although the DLSE investigates and issues civil
penalties and stop work orders for noncompliance with certain
labor laws, including laws relating to workers’ compensation, it
does not routinely refer employers that fail to provide workers’
compensation insurance to the fraud division for consideration
of possible criminal prosecution of fraud.
Without greater sharing of fraud information, the fraud division
is denied information that Industrial Relations possesses on
employers that fail to provide workers’ compensation insurance
for their employees. According to the fraud division chief, he
has sought to improve information sharing between the fraud
division and divisions within Industrial Relations through
possible memorandums of understanding. However, the chief
added that because of recent administration changes at Industrial
During 2003 the Relations, his contacts have changed and he has not been able to
Division of Labor finalize the planned memorandums of understanding.
Standards Enforcement
conducted 6,816 field The DLSE conducts field reviews of employers’ compliance
reviews and cited nearly with various labor laws as well as with the requirement that
1,300 employers for employers carry workers’ compensation insurance. During 2003
failing to carry workers’ the DLSE conducted 6,816 field reviews and cited nearly 1,300
compensation insurance. employers for failing to secure workers’ compensation insurance.
To enforce labor law requirements, the DLSE issues civil penalties
and can order employers to cease using employees in their
business operations (stop work orders) until the employers can
prove that they have obtained workers’ compensation insurance.
According to the assistant labor commissioner, the DLSE does
not refer employers that fail to provide workers’ compensation
insurance to the fraud division for possible investigation. She
stated that she is unsure of the benefits that would result from such
referrals because the DLSE already enforces workers’ compensation
insurance compliance on all employers it investigates. However,
9944 California State Auditor Report 2002-018 California State Auditor Report 2002-018 9955
the assistant labor commissioner also stated that after being
cited, some employers close up shop, declare bankruptcy,
liquidate their assets, and reopen at another location and
The Division of Labor continue to operate. The assistant labor commissioner also
Standards Enforcement’s stated that the DLSE does not track repeat offenders. As a result,
practice of not tracking the DLSE cannot gauge the effectiveness of civil penalties in
repeat offenders and deterring unlawfully uninsured employers. Therefore, the DLSE’s
not referring to the practice of not tracking repeat offenders and not referring to
fraud division employers the fraud division employers it identifies that fail to provide
it identifies that fail workers’ compensation insurance, denies the fraud division a
to provide workers’ tool it could use for identifying employers that repeatedly fail
compensation insurance to carry workers’ compensation insurance, thereby indicating a
denies the fraud division willful intent that warrants investigation.
a tool it could use for
identifying employers that
repeatedly fail to carry
INDUSTRIAL RELATIONS HAS YET TO IMPLEMENT
workers’ compensation
REQUIRED PROGRAMS DESIGNED TO DETER
insurance, thereby
WORKERS’ COMPENSATION FRAUD
indicating a willful
intent that warrants Recent legislation mandates that Industrial Relations implement
investigation. three antifraud programs: (1) a program to detect employers
that willfully fail to secure workers’ compensation insurance
for their employees; (2) a program establishing a protocol for
reporting suspected fraud by medical care providers; and (3) a
program requiring Industrial Relations to issue annual warnings
against committing workers’ compensation fraud to employers,
claims adjusters and administrators, medical providers, and
attorneys who participate in the workers’ compensation system,
and to notify them of the relevant penalties. The results of the
first two programs would be useful to the fraud division and
local district attorneys in their efforts to reduce fraud in the
workers’ compensation system, and the third program would
help deter fraud by notifying participants in the workers’
compensation system of the risks associated with committing
fraudulent activities. However, Industrial Relations has not
yet implemented these programs, citing budget constraints
and delays in executing an interagency agreement with the
Department of Insurance.
One Unrealized Program Would Enable the DLSE to
Identify Employers That Illegally Fail to Provide Workers’
Compensation Insurance
According to the assistant labor commissioner, Industrial
Relations has not yet established or implemented a program for
targeting employers in industries with the highest incidence
9944 California State Auditor Report 2002-018 California State Auditor Report 2002-018 9955
of unlawfully uninsured employers, even though the law
required such a program to be operational as of January 1, 2003.
The Commission on Under the program, the DLSE would work jointly with the
Health and Safety and Employment Development Department and the Workers’
Workers’ Compensation Compensation Insurance Rating Bureau (rating bureau) and
(commission) concluded would use data from the Uninsured Employers’ Fund, which
that a program targeting reimburses injured workers whose employers fail to provide
certain employers would, workers’ compensation insurance. The combined databases from
if implemented on a these entities would enable the DLSE to identify businesses that
permanent basis, be report wages but do not report having workers’ compensation
effective in identifying insurance coverage and to identify employers whose workers’
and enforcing mandatory compensation benefits have been paid by the Uninsured
insurance laws for Employers’ Fund maintained by Industrial Relations.
employers who unlawfully
fail to provide workers’ The program called for in the law is based on a pilot project
compensation insurance coordinated by the Commission on Health and Safety and Workers’
for their workers. Compensation. In a study of the pilot project released in 1999, the
Commission on Health and Safety and Workers’ Compensation
concluded that such a program would, if implemented on
a permanent basis, be effective in identifying and enforcing
mandatory insurance laws for employers that unlawfully fail to
provide workers’ compensation insurance for their workers. For
example, the study found that 60 percent of employers that were
uninsured at the beginning of the pilot project obtained insurance
after they received notices of noncompliance.
According to the assistant labor commissioner, the DLSE has
not established or implemented the program because it does
not have the resources to fund it or the ability to redirect
resources to the program from its current budget. The assistant
labor commissioner also told us that the DLSE’s budget change
proposal to fund the program was not approved. If the DLSE had
established this mandated program, it may have improved its
detection and deterrence of uninsured employers and provided
useful data to enhance the statewide antifraud effort.
The results of this required program would be useful to the
fraud division and local district attorneys in investigating and
prosecuting employers that willfully fail to provide workers’
compensation insurance. In the meantime, the fraud division
is working on a pilot project with the rating bureau to use
information from the rating bureau’s databases to identify fraud.
However, the information the fraud division provided us did not
adequately specify the objectives of its pilot project. If parts of
the fraud division’s pilot project duplicate the program required
of Industrial Relations that it has yet to implement, the costs to
9966 California State Auditor Report 2002-018 California State Auditor Report 2002-018 9977
the fraud division to operate the pilot project would represent
fraud assessment funds that could be redirected to other
antifraud priorities once Industrial Relations fulfills its obligation
to implement the program.
The Division of Workers’ Compensation Has Not
Implemented a Protocol for Reporting Potential Workers’
Compensation Fraud
According to Division of Workers’ Compensation (DWC) staff,
as of February 2004, the DWC had yet to implement the fraud-
reporting protocols that the law requires to be operational by
January 1, 2004. The legislation requires Industrial Relations
to develop a reporting system to help detect medical provider
fraud in the State. This type of fraud occurs when a medical
provider performs one service and bills for another more
expensive service or bills for a service that was never rendered,
and it carries a criminal penalty. According to the administrative
director of the DWC, the DWC has initiated the preliminary
research needed to develop the required protocols for reporting
medical provider fraud, but it has not established and
coordinated a system for reporting this type of fraud that the
DWC, fraud division, Medi-Cal Fraud Task Force, and Bureau
of Medi-Cal Fraud and Elder Abuse within the Department of
Justice can implement, as the law calls for. Without establishing
an effective means for these agencies to use in reporting
medical provider fraud, the DWC is missing an opportunity to
effectively target and reduce one type of fraud that the insurance
commissioner recognizes as high impact and high priority.
An Annual Warning to System Participants Against
Committing Workers’ Compensation Fraud Is Another
Process the DWC Has Yet to Initiate
The DWC has not established a process to warn employers,
claims adjusters and administrators, medical providers, and
attorneys who participate in the workers’ compensation system
against committing workers’ compensation fraud and inform
them of the penalties if they do. Recent legislation required
such a program to be operational as of January 1, 2003. In
its 1997 report on workers’ compensation antifraud efforts, a
Commission on Health and Safety and Workers’ Compensation
task force recommended that, in addition to investigative and
enforcement activities, notifying participants of the legal risks of
fraud is an important element in deterring it.
9966 California State Auditor Report 2002-018 California State Auditor Report 2002-018 9977
The law requires that the Fraud Assessment Commission (fraud
The Fraud Assessment commission) provide the DWC with the necessary funds to carry
Commission set aside out this notification. In fact, the fraud commission’s minutes
$200,000 for the for its January 2003 meeting show that the fraud commission
Division of Workers’ had set aside $200,000 for the DWC to use to fulfill this
Compensation (DWC) to responsibility and that the DWC would have to apply for the
use to establish a process funding in order to receive it. However, as of February 2004—
to warn employers, more than a year later—the DWC has not submitted an
claims adjusters, medical application. According to the DWC’s legal unit staff, it still has
providers, and attorneys not executed an interagency agreement with the Department of
against committing Insurance as required to apply for the funding.
fraud. However, as of
February 2004—over a
year later—DWC has not
INDUSTRIAL RELATIONS COLLECTS EXCESS FRAUD
applied for the funds.
ASSESSMENTS FROM INSURED EMPLOYERS
As described in the Introduction, Industrial Relations collects a
surcharge (fraud assessment surcharge) from employers to provide
the annual workers’ compensation fraud assessment, as determined
by the fraud commission, and deposits the funds it collects in a
special workers’ compensation fraud account in the Insurance
Fund. However, our review of Industrial Relations’ collection
processes reveals it cannot ensure that it is collecting the fraud
assessment surcharge equitably from the State’s employers.
Although Industrial Relations consistently transfers
the amount the fraud commission targets as the workers’
compensation fraud assessment to the Insurance Fund, we
found that it often collects much more than it intended
because the formula it uses to calculate the surcharge rate
usually results in overcharges to insured employers. Industrial
Relations holds any overcollections in a special deposit fund
and uses the balance of this fund to adjust the collection of the
subsequent year’s workers’ compensation fraud assessment. In
addition, even though Industrial Relations suspects that some
insurers may be retaining excessive fraud assessment surcharges
that they collect from employers, it has not implemented
procedures to ensure that insurers report and remit any
overcollections from insured employers.
The Formula Industrial Relations Uses to Determine the
Fraud Assessment Surcharge Results in Overcharges to
Insured Employers
To collect the aggregate workers’ compensation fraud assessment
determined by the fraud commission, Industrial Relations annually
devises a surcharge formula based on the Labor Code and Title 8 of
9988 California State Auditor Report 2002-018 California State Auditor Report 2002-018 9999
the California Code of Regulations. The DWC then determines the
amount due from the State’s insured and self-insured employers,
based on the employers’ respective payroll figures. The DWC
also notifies and collects the portion of the fraud assessment
due from insured employers, but it delegates the notification
and collection of the portion due from self-insured employers to
Industrial Relations’ Office of Self Insurance Plans, as required
by regulation.
Industrial Relations determines the two portions of the fraud
assessment surcharge differently. The Office of Self Insurance
Plans directly bills and collects a portion of the fraud assessment
surcharge from self-insured employers, and the remaining
portion is collected from employers through their respective
insurers. Figures 16 and 17 on the following pages show the
process Industrial Relations uses to collect the fraud assessment
surcharge from insured and self-insured employers.
Each year, Industrial Relations estimates and requests an
advance payment of the fraud assessment surcharge from
insurers that write workers’ compensation policies in California,
based on the projected policy premiums for the current year.
After paying the advance, the insurers collect the surcharge
through the premiums they charge employers. Later, when
the policy premiums are known and have been collected, the
insurers reconcile the amount of the fraud assessment they have
actually collected from employers with the amount of the initial
advance payment they made to Industrial Relations. Insurers are
expected to report any undercollection of the fraud assessment
surcharge from insured employers and remit any overcollection
to Industrial Relations.
Industrial Relations’ formula for calculating the fraud assessment
surcharge to be collected from insured employers results in very
large differences between the estimated and actual collections,
Industrial Relations’ signifying that the projection Industrial Relations uses to
formula for calculating compute it may be inaccurate. Each year, Industrial Relations
the fraud assessment holds overadvanced amounts from insurers and overcollections
surcharge to be collected from insured employers in its special deposit fund and uses the
from insured employers ending balance to adjust the aggregate workers’ compensation
results in very large fraud assessment authorized by the fraud commission for the
variations between following fiscal year. However, the adjustments have been
the estimated and disproportionately high in recent years and have resulted in
actual collections. large reductions. For example, to calculate the fraud assessment
surcharge to be collected from insured employers for fiscal year
2003–04—a year in which the workers’ compensation fraud
9988 California State Auditor Report 2002-018 California State Auditor Report 2002-018 9999
FIGURE 16
Process of Collecting Fraud Assessment Surcharges From Insured Employers
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110000 California State Auditor Report 2002-018 California State Auditor Report 2002-018 110011
FIGURE 17
Process of Collecting Fraud Assessment Surcharges From Self-Insured Employers
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assessment to be collected from insured employers was slightly
more than $24 million of the $32 million total assessment—
Industrial Relations increased the amount due from insured
employers by almost $7 million to make up for credits to
insurers for past years’ advance payments that were too high.
At the same time, Industrial Relations reduced the total amount
due from insured employers by almost $16 million, which it
had accumulated in its special deposit fund as of June 2003 from
overcollections from employers in prior years. After adjusting
for the credit of excessive advance payments to insurers
and overcollections from insured employers, the net fraud
assessment surcharge from insured employers for that year was
$14.5 million. This is just the most recent example. In fiscal year
2002–03, Industrial Relations reduced the total amount to be
collected from insured employers by more than $10 million that
it had accumulated in its special deposit fund.
To arrive at the amount that was overcollected from insured
employers, Industrial Relations directed insurers to apply an
excessive surcharge factor in the workers’ compensation policies
they wrote, which it based on premium projections from the
rating bureau. Industrial Relations’ regulations require that it
use the rating bureau’s projection of total current year premiums
to determine the fraud surcharge factor. However, information
provided by Industrial Relations suggests that the rating
bureau does not always provide accurate estimates of current
110000 California State Auditor Report 2002-018 California State Auditor Report 2002-018 110011
year premiums. In recent years, the rating bureau’s estimates
of current year premiums have been too low, resulting in
overcollections. However, in 1994 and 1995, the rating bureau’s
estimates were as much as 51 percent too high, which under
Industrial Relations’ formula for calculating fraud assessment
surcharges, would result in undercollections.
Industrial Relations Does Not Determine That Insurers
Correctly Report All Fraud Assessment Surcharges
Even though Industrial Relations suspects that some insurers do
not remit all their collected fraud assessment surcharges during
the reconciliation process, it has not established a method
to audit or otherwise verify the reconciliation submitted by
Industrial Relations staff insurers. Typically, when Industrial Relations asks insurers to
noted that in prior years reconcile their advances to the actual fraud assessment surcharge
some insurers reported they collect through premiums, insurers report that the initial
they did not bill their advance was either too much, in which case Industrial Relations
insured employers for credits them for the following assessment period, or too little,
fraud surcharges even in which case insurers remit the balance. However, Industrial
though the insurers Relations staff noted that in prior years, some insurers reported
showed premium income they did not bill their insured employers for fraud assessment
in those years. surcharges even though the insurers showed premium income
in those years. In addition, some insurers have reported that
the amount paid in advance exactly equaled the amount of
fraud assessment surcharges they billed to insured employers,
a circumstance that is very unlikely. As a result, Industrial
Relations staff suspect some insurers have misreported the
amount of fraud assessment surcharge they billed and collected.
Industrial Relations estimates of the amount of the workers’
compensation fraud assessment surcharge that insurers have
failed to remit ranges from roughly $8 million to $13 million
for 1999 through 2001. According to DWC staff, they cannot
verify that the reconciliation statements are correct because they
have no statutory authority to do so. However, without such
verification, Industrial Relations cannot ensure that it receives
all the fraud assessment surcharges collected by insurers.
RECOMMENDATIONS
To ensure that it receives the suspected fraud referrals it needs
from insurers to efficiently investigate suspected fraud, the fraud
division should continue its efforts to remove the barriers that
110022 California State Auditor Report 2002-018 California State Auditor Report 2002-018 110033
prevent insurers from providing the desired level of referrals.
Additionally, the Department of Insurance should seek the
necessary legal and regulatory changes in the fraud-reporting
program. These barriers include the following:
• Lack of a uniform methodology and standards for assessing
and reporting suspected fraud.
• Regulations that poorly define when insurers should report
suspected fraud to the fraud division.
• Perceived exposure to civil actions when criminal
prosecutions of referrals are not successful.
Given the number of referrals of suspected fraud cases by
insurers that the fraud division has decided not to investigate
because of a perceived lack of sufficient evidence to investigate
the referrals, the fraud division should work with insurers to
reduce the number of referrals that are not likely to result in
a successful investigation or prosecution, thereby preserving
limited resources. It should also work to ensure that the referrals
that insurers do make contain the level of evidence necessary
for the fraud division to assess the probability of a successful
investigation and prosecution.
Once the fraud division has determined the level of evidence
included with the suspected fraud referrals it needs from
insurers, it should implement a strategy for its special
investigative audit unit to focus the unit’s limited resources on
determining whether insurers are following the law in providing
the referrals that the fraud division needs. That strategy should
include the following elements:
• Clear objectives and priorities that will promote adequate
audit coverage of workers’ compensation insurers.
• Standards for conducting audits of insurers’ special
investigative units that include audit objectives, audit
procedures, methodologies for sampling claims transactions,
appropriate audit evidence, and supervision of the audits.
• Issue its audit reports promptly, periodically follow up on
audit findings, and develop effective methods of enforcing
compliance with the fraud-reporting requirements.
110022 California State Auditor Report 2002-018 California State Auditor Report 2002-018 110033
To help the fraud division investigate employers that fail to
secure workers’ compensation insurance for their employees,
the Industrial Relations’ DLSE should track employers that do
not provide workers’ compensation insurance or benefits for
their employees and report to the fraud division any employer
that repeatedly fails to provide workers’ compensation
insurance or benefits.
To ensure that it effectively targets employers in industries
with the highest incidence of unlawfully uninsured employers,
the DLSE should establish a program that uses data from the
Uninsured Employers Fund, the Employment Development
Department, and the rating bureau, as required by law.
To provide a mechanism to allow reporting of suspected medical
provider fraud, the DWC should implement the fraud-reporting
protocols required by law.
To help deter workers’ compensation fraud, the DWC should
warn participants in the workers’ compensation system of the
penalties of fraud, as required by law.
To avoid overcharging the State’s insured employers for the
workers’ compensation fraud assessment, Industrial Relations
should work with the rating bureau to improve the accuracy
of the projected premiums for the current year, which it uses
to calculate the fraud assessment surcharge ratio provided to
workers’ compensation insurers for collecting the surcharge from
insured employers.
To make certain that insurers do not withhold any portion of the
fraud assessment surcharge, Industrial Relations should seek
the authority and establish a method to verify that insurers
report and submit the workers’ compensation fraud assessment
surcharge they collect from employers.
110044 California State Auditor Report 2002-018 California State Auditor Report 2002-018 110055
We conducted this review under the authority vested in the California State Auditor by
Section 8543 et seq. of the California Government Code and according to generally accepted
government auditing standards. We limited our review to those areas specified in the audit
scope section of this report.
Respectfully submitted,
ELAINE M. HOWLE
State Auditor
Date: April 29, 2004
Staff: Doug Cordiner
Norm Calloway, CPA
Loretta T. Wright
Michael K. Adjemian
Felicity Wood
Matt Taylor
110044 California State Auditor Report 2002-018 California State Auditor Report 2002-018 110055
Blank page inserted for reproduction purposes only.
110066 California State Auditor Report 2002-018 California State Auditor Report 2002-018 110077
APPENDIX A
Recommendations From Various
Entities for Antifraud Grants to
District Attorneys
Table A.1, on the following page lists the funding
recommendations for fiscal year 2003–04 from the
entities involved in the process of awarding workers’
compensation fraud assessment funds to county district
attorneys. As we discussed in Chapter 1, to be eligible for
grants of fraud assessment funds to enhance investigation and
prosecution of workers’ compensation fraud, each interested
district attorney must submit an application.
The first two columns in the table list the county district attorneys
who applied for funding as well as the amount of funding
requested in each application. Once it receives these applications,
the Department of Insurance’s Fraud Division (fraud division)
reviews each application and develops a recommended funding
level for each district attorney. These recommendations are shown
in the third column of the table. The fraud division presents its
recommendations to the review panel, which is charged with
reviewing grant applications from the county district attorneys
and providing funding recommendations to the insurance
commissioner. The review panel recommendations shown in the
fourth column of the table indicate that in 19 cases, the review
panel agreed with the fraud division’s recommendations.
Before distributing the funds, the insurance commissioner must
determine, with the advice and consent of the Fraud Assessment
Commission (fraud commission), the most effective distribution
of the assessed funds. These figures appear in the table’s fifth and
sixth columns, respectively. Neither the insurance commissioner
in his recommendations nor the fraud commission when giving
its advice and consent altered the recommendations of the review
panel. Therefore, each county district attorney was awarded the
amount shown in the last column for fiscal year 2003–04.
110066 California State Auditor Report 2002-018 California State Auditor Report 2002-018 110077
TABLE A.1
Recommendations for Awarding Fraud Assessment Funds for Fiscal Year 2003–04
Insurance Fraud Assessment
County District Requested Fraud Division Review Panel Commissioner Commission Advice
Attorney Amount Recommendation Recommendation Recommendation and Consent Final Award
Alameda $ 1,428,081 $ 950,000 $ 1,000,000 $ 1,000,000 $ 1,000,000 $ 1,000,000
Amador 227,000 100,000 85,000 85,000 85,000 85,000
Butte 320,000 50,000 81,000 81,000 81,000 81,000
Contra Costa 556,718 350,000 375,000 375,000 375,000 375,000
El Dorado 51,129 43,000 43,000 43,000 43,000 43,000
Fresno 948,388 700,000 700,000 700,000 700,000 700,000
Imperial 42,736 20,400 42,736 42,736 42,736 42,736
Kern 324,342 300,000 324,000 324,000 324,000 324,000
Kings 202,616 100,000 80,000 80,000 80,000 80,000
Los Angeles 6,322,485 4,300,000 4,300,000 4,300,000 4,300,000 4,300,000
Marin 228,390 145,000 145,000 145,000 145,000 145,000
Mendocino 22,199 21,111 21,111 21,111 21,111 21,111
Merced 86,557 50,000 41,156 41,156 41,156 41,156
Monterey 258,848 210,000 210,000 210,000 210,000 210,000
Orange 1,593,920 1,100,000 1,050,000 1,050,000 1,050,000 1,050,000
Plumas 5,430 5,164 5,164 5,164 5,164 5,164
Riverside 747,623 550,000 500,000 500,000 500,000 500,000
Sacramento 1,018,764 900,000 900,000 900,000 900,000 900,000
San Bernardino 1,063,396 900,000 850,000 850,000 850,000 850,000
San Diego 3,695,698 2,700,000 2,648,565 2,648,565 2,648,565 2,648,565
San Francisco 857,070 700,000 675,000 675,000 675,000 675,000
San Joaquin 499,958 350,000 350,000 350,000 350,000 350,000
San Luis Obispo 63,852 60,721 60,721 60,721 60,721 60,721
San Mateo 461,424 300,000 300,000 300,000 300,000 300,000
Santa Barbara 212,048 150,000 150,000 150,000 150,000 150,000
Santa Clara 1,300,000 1,000,000 1,000,000 1,000,000 1,000,000 1,000,000
Santa Cruz 118,013 90,000 90,000 90,000 90,000 90,000
Shasta 271,000 135,000 151,500 151,500 151,500 151,500
Siskiyou 15,098 11,000 6,443 6,443 6,443 6,443
Solano 97,867 93,068 93,068 93,068 93,068 93,068
Sonoma 392,084 130,000 175,000 175,000 175,000 175,000
Stanislaus 274,265 274,265 274,265 274,265 274,265 274,265
Tehama 13,397 13,397 13,397 13,397 13,397 13,397
Tulare 268,748 150,000 150,000 150,000 150,000 150,000
Ventura 482,182 339,000 400,000 400,000 400,000 400,000
Yolo 166,795 140,742 140,742 140,742 140,742 140,742
Totals $24,638,121 $17,431,868 $17,431,868 $17,431,868 $17,431,868 $17,431,868
110088 California State Auditor Report 2002-018 California State Auditor Report 2002-018 110099
APPENDIX B
The Fraud Division’s Referral Form
for Suspected Fraudulent Claims
The fraud referral form shown in Figure B.1 on the
following pages is completed by insurers, informants,
witnesses, law enforcement agencies, and Department
of Insurance’s Fraud Division (fraud division) investigators to
report suspected fraudulent activity. After the fraud division
receives a referral form and catalogs it in a database, supervisors
review the form and inform the insurer that sent the referral
about the disposition of the referral. Specifically, the supervisor
will tell the insurer whether the referral will be opened for
investigation, needs additional information, or will be closed for
various reasons including insufficient evidence.
110088 California State Auditor Report 2002-018 California State Auditor Report 2002-018 110099
FIGURE B.1
SFC Referral Form (FD-1)
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111100 California State Auditor Report 2002-018 California State Auditor Report 2002-018 111111
ĀȀ̀ЀԀ܀ࠀЀȀऀఀȀ܀ഀࠀഀऀԀऀༀࠀကᄀ܀Ȁࠀሀ ጀ܀Ȁᄀ᐀ऀЀᔀЀကЀࠀ
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111122 California State Auditor Report 2002-018 California State Auditor Report 2002-018 111133
Agency’s comments provided as text only.
Department of Insurance
300 Capitol Mall, Suite 1700
Sacramento, California 95814
April 13, 2004
Ms. Elaine M. Howle*
State Auditor
Bureau of State Audits
555 Capitol Mall, Suite 300
Sacramento, CA 95814
RE: BSA Audit 2002-018: Workers’ Compensation Fraud: Response to Final Report
Dear Ms. Howle:
The California Department of Insurance has reviewed the Bureau of State Audits’ draft report
entitled, “Workers’ Compensation Fraud: Detection and Prevention Efforts Are Poorly Planned and
Lack Accountability.” The audit is a retrospective review of the fraud program as administered by
several previous insurance commissioners and includes the first twelve months of my current term
in office.
When I assumed office in 2003, one of my greatest challenges was the workers’ compensation
crisis facing California. Employers faced with escalating premiums were particularly concerned
about reducing workers’ compensation fraud. Although difficult to quantify, fraud does have a signifi-
cant impact on the effectiveness of the system.
Therefore, one of my first acts was to reorganize and reenergize the fraud investigation efforts of
this Department. We reorganized the Fraud Division, assigned a new director, Dale Banda, and
created a special Workers’ Compensation bureau naming Kathy Scholz to coordinate our statewide
efforts. We directed our Fraud Division to focus on workers’ compensation fraud and we prioritized
cases to maximize the investigative and enforcement aspect of our efforts and improve coordination
with district attorneys. We also worked to enhance the deterrent effect that publicizing arrests and
prosecutions has on potential offenders.
During the 2003 legislative session, working with the legislature and the Governor, we were able to
enact a number of significant medical cost containment reforms by establishing fee schedules and
utilization controls. While these structural changes will result in savings of approximately $5 billion
and will reduce the opportunities for abuse and fraud through simplification and clarification of the
statute, more fundamental reform is needed.
* California State Auditor’s comments begin on page 131.
111122 California State Auditor Report 2002-018 California State Auditor Report 2002-018 111133
Ms. Elaine Howle
April 13, 2004
Page 2 of 2
An equally important component of our fraud efforts is my goal to strengthen the criminal penalties
for fraud and to expand immunity from liability for those who report fraud. I have requested that
these anti-fraud measures be addressed during the special legislative session.
I appreciate the thoroughness of the Bureau of State Audits’ report. It describes a number of find-
ings and recommendations that we also identified and have acted upon this past year. Please see
our overview and response to the recommendations.
We look forward to describing our specific progress in making further changes over the next year.
Sincerely,
(Signed by: John Garamendi)
John Garamendi
Insurance Commissioner
111144 California State Auditor Report 2002-018 California State Auditor Report 2002-018 111155
California Department of Insurance
Response to the Bureau of State Audit Report 2002-18
Workers’ Compensation Fraud: Detection and Prevention Efforts Are
Poorly Planned and Lack Accountability
Response Overview
Introduction--Bureau of Fraudulent Claims (Fraud Division)
In evaluating the audit findings, we must start with the statutory mandate for the investigation of
fraudulent claims. California Insurance Code section 1872.83(a) states that “The commissioner
shall ensure that the Bureau of Fraudulent Claims (Fraud Division) aggressively pursues all
reported incidents of probable workers’ compensation fraud….” In the 25-year existence of
the Division, it has fulfilled this statutory responsibility by accepting all probable or “suspected
fraud” referrals from insurers, evaluating each referral and prioritizing investigations based on
the evidence and available resources. In 2003 insurer premium for workers’ compensation
insurance coverage approximated $21 billion. For 2003-04, the cost of the Department’s effort
to investigate and prosecute fraud amounted to $34.5 million or .164 percent of total insurer
premium.
Over the past five reported years, the combined local and state fraud program costs were
$150,492,500 compared to the $550,223,978 in chargeable fraud prosecuted during this same
period. It should be noted that chargeable fraud is a figure that represents the amount the
prosecutor believes can be proven in court. This figure is often far less than the actual fraud
committed. With respect to this five year history, the return on investment has been $3.65 for
each dollar spent by the program. Not as simple to measure, but even more important is the
deterrent value of publicizing successful fraud investigations and prosecutions. For example,
after a significant applicant fraud case was prosecuted involving the Los Angeles County
Metropolitan Transit Authority (MTA) and an anti-fraud awareness campaign was conducted, the
rate of workers’ compensation claims there fell by 29% compared to the preceding year.
Measuring fraud
The auditors criticize the program for not having a baseline measure of the incidence of fraud in
the workers’ compensation system. They argue that the absence of such a baseline hampers
the Department’s ability to plan, deploy resources and ensure accountability. The Department
agrees that valid estimates of the incidence of workers’ compensation fraud would be useful
and could aid in resource allocation. However, implicit in the auditor’s statements is an incorrect
1
assumption, i.e. that an increase in fraud enforcement efforts alone will reduce the incidence of
fraud or the fraud rate.
1
111144 California State Auditor Report 2002-018 California State Auditor Report 2002-018 111155
A variety of other factors are equally or more determinative of the incidence of fraud at any
given time. For example, applicant fraud is likely to rise during recessions, where employees
face the possibility of layoffs or have lost their jobs. Similarly, a hardened market for workers’
compensation insurance will increase the occurrence of premium fraud as well as the number
of willfully uninsured employers. Finally, the complexity of the current law invites claim abuse by
medical providers. Each of these factors impacts the incidence of fraud independent of increased
or decreased enforcement efforts.
As noted earlier, the Department acknowledges the value of measuring the incidence of fraud to
gauge the impact of fraud investigations and prosecutions. Therefore, the Department identified
related research in preparation for engaging a study. The recurring theme of this research was
the difficulty in measuring fraud and the recognition that no directly relevant studies have been
undertaken. The auditors acknowledge these difficulties and suggest the experience of the
Internal Revenue Service and the Centers for Medicare and Medicaid Service can serve as an
approach we may wish to examine. We note that both of these federal agencies have robust
databases from which to mine relevant data. The California workers’ compensation system does
2
not currently have a comprehensive database for such research; however, we are discussing with
the Workers’ Compensation Insurance Rating Bureau of California and the California Workers’
Compensation Institute how to gain access to their data sources in order to pursue this research.
Planning
The Bureau of State Audits (BSA) identified a lack of strategic planning. After taking office, we
recognized the need for the Department to develop more results oriented business plans. Every
unit in the department, including the Fraud Division has taken the first steps in producing such
plans. These new plans identify goals, objectives and action plans consistent with vision and
strategic initiatives the Commissioner has articulated.
The current business plan was initiated in 2003. The Fraud Division continues to refine its initial
plan based on trend information it obtains from “suspected fraud” referrals, data from other
governmental agencies, district attorneys and through collaborative meetings with the Fraud
Assessment Commission (FAC) and other stakeholders.
In 2003, the Fraud Division commenced reporting on its findings through the use of
measurements such as the number of suspected fraud referrals evaluated, case investigations
3
and case completions. It will report result-measures such as the number of convictions,
restitutions, fines, regulatory actions, penalties, and return on investment as part of its 2004-05
plans.
2
111166 California State Auditor Report 2002-018 California State Auditor Report 2002-018 111177
Awarding and monitoring grants
4
BSA states that the grant awards are not determined using established priorities. Contrary to this
assertion, the FAC recommends funding for workers’ compensation fraud abatement on the basis
of guidelines and criteria set forth in the California Insurance Code (CIC) Section 1872.83(b)(4)
and 10 California Code of Regulations Section 2698 et seq. Notably, neither the CIC nor the
CCR permit the use of alternate criteria for suggesting funding levels. A discussion of the
codified criteria is included in the Appendix.
The Department recognizes that the statute does allow it to amend the regulations to place more
emphasis on district attorney performance as a basis for grant award. In keeping with the BSA’s
recommendation, the Department will amend the regulations to improve the award process, grant
management, and independent auditing requirements.
Insurer standards for reporting suspected fraud and compliance
BSA has stated that the Fraud Division could more effectively manage its investigative efforts
5
if the standard of evidence required in the insurer referral process was strengthened. As
described previously, CIC section 1872.83(a) mandates the Commissioner to accept and
pursue all reported incidents of probable workers’ compensation fraud. It is important that all
insurers submit all suspected fraudulent claims for trend analysis and for setting priorities. This
information often identifies a pattern of criminal activity that otherwise would go undetected.
6
Under the current statutory referral criteria, we must evaluate all case referrals. The auditors
identified approximately 84 percent of investigative time did result in case submission to a
prosecutor. Cases are selected based on the best probability for prosecution, however, every
case has uncertainties. Therefore, we do not believe that a 16% case closure rate is excessive,
but rather acceptable.
The Division agrees that improvements can be made in the quality and consistency of insurer
referrals. To this end, emergency regulations were adopted on September 4, 2003. These
regulations are now being refined through a formal process involving insurers and other
stakeholders. Permanent regulations are scheduled for adoption in October 2004.
We welcome the comments of the BSA as an opportunity to build on this foundation and to
continue to improve the cost effectiveness of our program.
Provided below are specific comments addressing each audit
report recommendation.
Chapter One
Recommendation 1:
Revamp its decision-making process so that it includes the best information available, including
the results of the Department of Insurance’s analyses of the nature and extent of fraud in the
Workers’ Compensation system once they are completed, the effectiveness of prior years’ efforts
3
111166 California State Auditor Report 2002-018 California State Auditor Report 2002-018 111177
to reduce fraud on the part of the fraud division and district attorneys that are linked to their
respective program objectives, and any newly emerging trends in fraud schemes that should
receive more attention.
Response to recommendation:
The Department of Insurance concurs-in part: The Department believes BSA has not given
7
adequate consideration to the complexity of analyzing the nature and extent of fraud in the
workers’ compensation system. However, the Department has been working with the new
chairman of the Fraud Commission to develop a strategy to improve the efficiency, consistency
and accountability in the decision-making process. The Department, along with the District
Attorneys, will work with the commission to provide the best information available on reported
fraud and trends; continue with round-table discussions pertaining to anti-fraud efforts; and make
adjustments to program objectives focused on reducing fraud.
Recommendation 2:
Request an annual proposal from the fraud division that outlines its objectives and measurable
outcomes linked to its objectives from the prior year and its objectives for the ensuing year, and
the expenditures planned by the fraud division to accomplish those objectives.
Response to recommendation:
The Department of Insurance concurs: The Department will work closely with the Fraud
Commission so that its vision, objectives, and priorities align with the Insurance Commissioner’s
strategic initiatives. The Department will amend its Business Plan and internal processes
consistent with the FAC and Insurance Commissioner’s priorities.
Recommendation 3:
Request, in addition to the information currently required of each county district attorney planning
to participate in the program, a report listing the district attorney’s accomplishments in achieving
the goals and objectives outlined in the prior year’s application and the goals and objectives for
the ensuing year and the estimated cost of the year’s activities to achieve them, along with a
description of how those goals and objectives align with the program goals described by the fraud
commission and insurance companies.
Response to recommendation:
The Department of Insurance concurs: The Department intends to amend the relevant regulations
and will be presenting funding guidelines to the FAC that focus on district attorney performance,
past and future.
4
111188 California State Auditor Report 2002-018 California State Auditor Report 2002-018 111199
Recommendation 4:
Develop and implement a process for awarding fraud assessment grants that provides
consistency among those making funding recommendations by incorporating standard decision-
making criteria and a rating system that supports funding recommendations.
Response to recommendation:
The Department of Insurance concurs: The Department will adopt amended regulations that
base awards on measurable performance criteria. But in keeping with statute and case law, the
members of the FAC can consider additional information in making their funding decisions.
Recommendation 5:
Include in the decision-making criteria how well the county district attorneys’ proposals for using
the assessment funds align with the strategy and priorities developed by the fraud commission
and the Insurance Commissioner, as well as the district attorneys’ effectiveness in meeting the
prior year’s objectives.
Response to recommendation:
The Department of Insurance concurs: The Request for Funds Application (RFA) is being revised
to provide greater focus on performance. The amended RFA will ask the district attorneys to
address their performance and caseload priorities. The district attorneys will be required to
describe prior year’s accomplishments as well as proposed plans to meet the objectives identified
by the Insurance Commissioner and the FAC.
Recommendation 6:
Document the rationale for how decisions on recommendations for grant awards are made.
Response to recommendation:
The Department of Insurance concurs: The Department will adopt procedures to document the
decision process.
Recommendation 7:
Reevaluate the Department of Insurance regulations pertaining to how indirect costs are charged
to fraud assessment grants to determine whether the regulations provide the desired amount
of control, and seek changes in the regulations if required, and ensure that all county district
attorneys that apply for fraud assessment grants disclose their method of charging indirect costs.
5
111188 California State Auditor Report 2002-018 California State Auditor Report 2002-018 111199
Response to recommendation:
The Department of Insurance concurs: The Department will amend the regulations to clarify
allowable indirect costs.
Recommendation 8:
Change its past policy of awarding the base portion of fraud assessment grants to county
district attorneys exclusively on whether they submitted a completed application by the required
deadline and instead make recommendations for grant awards, including the base allocations, on
evaluations of county district attorneys’ plans that include how the funds will be used, as required
by Department of Insurance regulations.
Response to recommendation:
The Department of Insurance concurs: The Department will amend the regulations to the extent
the law allows, to better ensure that fraud assessments are distributed to district attorneys who
most effectively investigate and prosecute workers’ compensation fraud
Recommendation 9:
Determine whether the provisions of the Bagley-Keene Open Meeting Act apply to the review
panel’s meetings to recommend fraud assessment grants to county district attorneys and, if it
does, seek a specific exemption for discussions of those portions of the county district attorneys’
applications for grant awards that include confidential criminal investigation information while
keeping those parts of the meeting discussing recommendations for district attorney funding
levels open to the public and ensure that the review panel complies with the requirements.
Response to recommendation:
The Department of Insurance is currently reviewing the applicability of the Bagley-Keene Act to
the Review Panel process as codified by 10 CCR 2698 et.seq. and if appropriate the Department
shall request legal guidance from the Attorney General.
Recommendation 10:
Continue current efforts to establish performance measures that can be used to evaluate
the effectiveness of the fraud division and participating district attorneys in reducing workers’
compensation fraud. Such measures can also assist in determining the appropriate amount
of funds to be assessed and divided between the fund division and grants for county district
attorneys. Finally, these measures could assist in arriving at a recommendation for individual
grant awards to the county district attorneys and the fraud division.
6
112200 California State Auditor Report 2002-018 California State Auditor Report 2002-018 112211
Response to recommendation:
The Department of Insurance concurs: Shortly after taking office, the Insurance Commissioner
directed the Fraud Division to develop a Business Plan that would align with the Department’s
vision, goals and strategic initiatives. In developing the Business Plan, the Fraud Division
considered its internal strengths, weaknesses, and past performance. The Fraud Division
acknowledges the need to address performance measures both internally (investigations) and
externally (prosecutions) within its Business Plan and will be working with the FAC, District
Attorneys and other stakeholders to accomplish this result.
Chapter 2
Recommendation 11:
In addition to investigating fraud, the fraud division should recognize its other responsibilities,
including advising the fraud commission and the Insurance Commissioner using documented
past performance and future projections on the optimum annual amount of aggregate
assessment needed by the program to fight workers’ compensation fraud and the most effective
distribution of the funds assessed to investigate and prosecute workers’ compensation fraud and
reporting on the economic value of insurance fraud and making recommendations to reduce it.
Response to recommendation:
The Department of Insurance concurs: The Department will allocate resources to address fraud
research, trends analysis, and effective funding disbursement methods, and improved oversight
of county grants. The Department will also reactivate an advisory committee made up of
stakeholders dedicated to fighting workers’ compensation fraud to provide input about the affects
of fraud and suggest priorities for reducing it.
Recommendation 12:
After recognizing its responsibilities, modify its business plan to meet those responsibilities,
including establishing appropriate goals and objectives, activities, and priorities.
Response to recommendation:
The Department of Insurance concurs: (See response on recommendation 10.)
7
112200 California State Auditor Report 2002-018 California State Auditor Report 2002-018 112211
Recommendation 13:
The fraud division should establish benchmarks that it can use to measure its and district
attorneys’ performance in meeting goals and objectives, and to determine whether the program is
operating as intended and resources are appropriately allocated.
Response to recommendation:
The Department of Insurance concurs: (See response on recommendation 10.)
Recommendation 14:
To fulfill its non-investigative roles, the fraud division should realign its resources to maintain
an adequate effort to conduct the research necessary to fulfill its statutory role as an advisor
regarding the level of funding and the direction of fraud reduction efforts, including efforts to
measure the nature and extent of fraud in the workers’ compensation system and the effect
of antifraud efforts, monitor the performance of county district attorneys who receive grants of
fraud assessment funds, and conduct the research necessary to meet its advisory and reporting
responsibilities.
Response to recommendation:
The Department of Insurance concurs with this recommendation: (See recommendation 11.)
Recommendation 15:
Reevaluate its suspected fraud reporting process to identify the type of referrals and level of
evidence it requires in those referrals to reduce the number of hours it spends on referrals that
ultimately do not result in submittal to county district attorneys for prosecution.
Response to recommendation:
The Department of Insurance concurs-in part: The current relevant statutes include: California
Insurance Code section 1872.4 mandates that insurers refer all suspected fraudulent claims to
the Department; California Insurance Code 1872.83(a) mandates the commissioner shall ensure
that the Bureau of Fraudulent Claims aggressively pursues all reported incidents of probable
workers’ compensation fraud; and California Insurance Code 1877.3(b)(1) mandates that when
an insurer knows or reasonably believes it knows the identity of a person or entity whom has
reason to believe committed a fraudulent act relating to a workers’ compensation insurance claim
or a policy shall notify the local district attorney’s office and the Bureau of Fraudulent Claims of
that suspected fraud and provide the basis of the suspected fraud.
While the Department will reevaluate its referral process and evidence standards, this will be done
within the context of existing statutes. The Department believes it is important that all insurers
submit all suspected fraudulent claims for trend analysis and the establishment of priorities. This
information often identifies a pattern of criminal activity that otherwise would have gone undetected.
In accordance with BSA’s recommendation the Department will review internal procedures in an
attempt to reduce the number of hours that do not result in a case submission to prosecutors.
8
112222 California State Auditor Report 2002-018 California State Auditor Report 2002-018 112233
Recommendation 16:
Clarify its expectations for the independent audits by seeking a change in the Department of
Insurance regulations that require audit reports to provide an opinion on county district attorneys’
level of compliance with key provisions of the applicable laws, regulations, and terms of the fraud
assessment grants.
Response to recommendation:
The Department of Insurance concurs: The Department will amend the regulations to clarify the
independent audit requirements.
Recommendation 17:
Ensure the county district attorneys comply with the independent audit requirements and
promptly submit their audit reports.
Response to recommendation:
The Department of Insurance concurs: Compliance with the submittal of the independent audit
reports will be a condition of continuing funding.
Chapter 3
Recommendation 18:
Clear objectives and priorities that will promote adequate audit coverage of workers’
compensation insurers.
Response to recommendation:
The Department of Insurance concurs: (See response recommendation 20.)
Recommendation 19:
Standards for conducting audits of insurers’ special investigative units that include audit
objectives, audit procedures, methodologies for sampling claims transactions, appropriate audit
evidence, and supervision of the audits.
Response to recommendation:
The Department of Insurance concurs: (See response recommendation 20.)
9
112222 California State Auditor Report 2002-018 California State Auditor Report 2002-018 112233
Recommendation 20:
Issue its audit reports promptly and periodically follow up on audit findings. Also develop
equitable methods of enforcing compliance with the fraud reporting requirements.
Response to recommendation:
The Department of Insurance concurs: The Department is developing a standardized approach
to insurer audits that will allow us to target insurers and achieve maximum compliance with
reporting requirements.
10
112244 California State Auditor Report 2002-018 California State Auditor Report 2002-018 112255
Appendix
Grant Awards
The following supplements the “Awarding and Monitoring Grants” section of the main text found on
page 3.
CCR Section 2698 elucidates general funding procedures for distribution of special funds estab-
lished by CIC 1872.83(b) (4).i CCR Section 2698.53 identifies such funding as a “grant award”.ii
CCR Section 2698.54 apportions “grant awards” into two categories, dictates the percentage of
CIC Section 1872.83(b)(4) funds that shall be directed at each, mandates that participating district
attorneys submit “county plans”, and requires fund distribution to be based thereon.iii CCR Section
2698.55 defines the necessary elements of a “county plan”.iv Finally, CCR Section 2698.57 estab-
lishes the overall criteria to be used in determining funding and permits funding despite inadequate
county plans given the importance of combating workers’ compensation fraud.v
8
Thus the rationale used by the Review Panel to distribute funds is already codified and requires no
further description or explanation. As noted previously, no authority exists for the Review Panel to
form a recommendation based on criteria other than that which is codified. Recommending funding
despite an inadequate “county plan” can be permissible given a known presence of workers’ com-
pensation fraud or the need to establish an abatement effort in the area.
To the extent that Review Panel members must interpret performance and need based on the
mandated criteria, each is afforded great discretion and unless shown to be arbitrary & capricious,
courts shall uphold such interpretations and refuse to intervene.vi Moreover, courts presume the
legitimacy of such interpretation and the complainant carries the burden of establishing otherwise.vii
Insurer Referrals
The following supplements the “Insured standards for reporting suspected fraud and compliance”
section of the main text found on page 3.
The Legislature, through CIC Section 1871 declared workers’ compensation fraud abatement to
be a high priority as the effects of such fraud are harmful to the state, its economy and a burden to
California taxpayers.viii As a result, the Legislature requires that suspicions, evens those based on
little evidence be pursued. Specifically, the Legislature mandates, through CIC 1872.4, that insur-
9
ers refer all suspected fraudulent claims to the DOI unless statutorily specified circumstances exist
and that the DOI investigate all such referrals.ix
Additionally, the Legislature, through CIC 1872.3, mandates that the DOI, specifically its Fraud
Division, investigate all suspected instances of fraudx. Thus it is the Legislature that has purpose-
fully created a low evidentiary standard for the investigation and prosecution of these frauds. The
reasoning being a historical failure by insurers to refer such matters and the importance of abating
workers’ compensation fraud.
i
112244 California State Auditor Report 2002-018 California State Auditor Report 2002-018 112255
i “These regulations are promulgated pursuant to authority granted to the Insurance Commissioner
under the provisions of Section 1872.83 of the California Insurance Code. The purpose of these
regulations is to set forth the criteria for distribution of funds to district attorneys for enhanced inves-
tigation and prosecution of workers’ compensation insurance fraud cases, including an application
process and subsequent reporting requirements.”
ii 10 CCR 2698.53 states, in pertinent part,
“(a) Funding shall be in the form of a Grant Award Agreement and shall require an enabling resolu-
tion approving and authorizing execution of the agreement by the county Board of Supervisors.
iii CCR Section 2698.54 states, in pertinent part,
“Each district attorney’s allocation shall consist of two parts: a base allocation and a program
award, both made as a result of the evaluation of the county plans. The base allocation shall be
made from fifty percent (50%) of the total funds and allocated according to the following “caseload
estimate”, an estimate of the district attorney’s proportional share of the state’s workers’ compensa-
tion fraud investigation and prosecution caseload:
(a) The county’s proportion of the state’s annual average number of workers engaged in wage and
salary employment for the most recent year of report shall receive the greatest weight and shall
account for sixty-six percent (66%) of the base allocation funding. The employment data source is
the Employment Development Department Annual Planning Information.
(b) The county’s proportion of the state’s workers’ compensation suspected fraudulent claims as
reported to the California Department of Insurance over the previous three years shall account for
thirty-four percent (34%) of the base allocation funding. The source for data on the number of sus-
pected fraudulent claims reported to the Division is the California Department of Insurance.
iv CCR § 2698.55 states, in pertinent part,
The County Plan shall include but need not be limited to the following elements detailing the coun-
ty’s qualifications and the manner in which the district attorney will use the funds to investigate and
prosecute workers’ compensation insurance fraud:
(a) Qualifications.
(1) A description of the district attorney’s experience in investigating and prosecuting workers’ com-
pensation insurance fraud. Relationships with other public or private entities which may be useful to
the program should also be included. Specific activity during the past two years should be detailed
as follows:
(A) Number of investigations initiated, specifying number of identified suspects per investigation;
(B) Number of warrants or indictments issued, specifying number of suspects and/or defendants;
(C) Number of arrests made;
(D) Number of convictions obtained, specifying number of defendants, number obtained by trial
verdict and number obtained by plea or settlement;
(E) Amount of fines and penalty assessments ordered and collected, specifying number of defen-
dants; and
ii
112266 California State Auditor Report 2002-018 California State Auditor Report 2002-018 112277
(F) Amount of restitution ordered and collected, specifying number of defendants and victims.
(2) The panel shall consider each applicant county’s population size in proportion to its historic
commitment of resources to insurance fraud investigation and prosecution.
(b) Plan. The district attorney’s plan for investigation and prosecution of workers’ compensation
fraud, including, at a minimum, the following elements:
(1) Problem Statement. A description of the extent and nature of the problem in the county, includ-
ing its sources and causes, its economic and social impact, its unique aspects, if any, and what
is needed to resolve the problem. Supporting data, evidence, or indicators of fraudulent activity
related to workers’ compensation insurance should be included. The data and information may be
derived from third party administrators, self-insured employers, other local law enforcement entities,
insurers or the Fraud Division or the Investigation Bureau of the California Department of Insurance.
(2) Program Strategy. This section shall specify how the district attorney will use program funds to
address the problem defined above including:
(A) Outreach. A description of the manner in which the district attorney will develop his or her case-
load, the source(s) for referrals of cases for investigation and/or prosecution, whether directly from
the Division and/or directly from self-insured employers, third-party administrators and insurers or a
combination;
(B) Personnel. The number, position titles and position justification of personnel to be funded fully or
in part through grant funds, including descriptions of the qualifications of personnel to be assigned
to the program and an organization chart identifying positions to be funded;
(C) Program Coordination. A description of the manner in which the district attorney plans to coor-
dinate involved sectors, including employers, insurers, medical and legal provider communities, the
Fraud Division and the Investigation Bureau of the California Department of Insurance;
(D) Management Plan. The detailed plan and schedule of the steps the district attorney will com-
plete in achieving the objectives of the program and a discussion of how the program will be orga-
nized and what internal quality control and budget monitoring procedures will be employed. This
part should also include how this program will be integrated with any other anti-fraud program(s)
maintained within the district attorney’s office;
(E) Staff Development. The plan for ongoing training of personnel on the workers’ compensa-
tion system and the investigation and prosecution of fraud. Staff development may be addressed
through coordination with the Division insurers or other entities.
(3) Objectives. This section shall outline the district attorney’s anticipated achievements in the fol-
lowing areas:
(A) Estimated number of investigations to be initiated during the grant period, including a separate
estimate of the number resulting from carryover investigations; and
(B) Estimated number of prosecutions to be initiated during the grant period.
iii
112266 California State Auditor Report 2002-018 California State Auditor Report 2002-018 112277
v CCR § 2698.57 states,
Based on the Review Panel’s evaluation of each County Plan, the Panel will forward funding rec-
ommendations to the Commissioner. If the County Plan fails to respond adequately to the required
0
items as specified in Sections 2693.6 and 2693.7, the Panel may recommend funding at the district
attorney’s base allocation level; however, the Panel shall consider the importance of establishing a
program presence in a county to increase community awareness and deter workers’ compensation
fraud. However, Applications which fail to meet the specified criteria may be recommended for no
funding.
vi “the construction of a statute by officials charged with its administration... is entitled to great
weight” (Morris v. Williams, 67 Cal. 2d 733, 748 [63 Cal. App. 689, 433 P.2d 697]), and “if there
appears to be some reasonable basis for the classification, a court will not substitute its judgment
for that of the administrative body” (Rible v. Hughes, 24 Cal. 2d 437, 445 [150 P.2d 455, 154 A.L.R.
137]). “[T]he court should not substitute its judgment for that of an administrative agency which acts
in a quasi-legislative capacity. [A court] will not, therefore, superimpose its own policy judgment
upon the agency in the absence of an arbitrary and capricious decision.” (Pitts v. Perluss, 58 Cal.
2d 824, 832 [27 Cal. Rptr. 19, 377 P.2d 83]; see also Ralphs Grocery Co. v. Reimel 69 Cal. 2d 172,
179 [70 Cal. Rptr. 407, 444 P.2d 79].) “If reasonable minds may well be divided as to the wisdom
of an administrative board’s action, its action is conclusive.’ (Rible v. Hughes, supra, at p. 445.)’
“... Courts and commentators have therefore centered their attention on an assurance of judicial
abstention in areas in which the responsibility for basic policy decisions has been committed to
coordinate branches of government. Any wider judicial review, we believe, would place the court in
the unseemly position of determining the propriety of decisions expressly entrusted to a coordinate
branch of government. Moreover, the potentiality of such review might even in the first instance
affect the coordinate body’s decision-making process....” (Id.) We conclude that the decision making
process of the commission and the regional commissions in granting or denying a coastal develop-
ment permit is a task involving basic policy decisions of the type contemplated by the Johnson case
discussion, and therefore is a discretionary act within the meaning of the Tort Claims Act. Also see
“... Courts and commentators have therefore centered their attention on an assurance of judicial
abstention in areas in which the responsibility for basic policy decisions has been committed to
coordinate branches of government. Any wider judicial review, we believe, would place the court in
the unseemly position of determining the propriety of decisions expressly entrusted to a coordinate
branch of government. Moreover, the potentiality of such review might even in the first instance
affect the coordinate body’s decision-making process....” (Id.)
vii In addition, it has been said that an administrative ruling ‘comes before the court with a presump-
tion of correctness and regularity, which places the burden of demonstrating invalidity upon the
assailant [fn. omitted].’ (California Assn. of Nursing Homes etc., Inc. v. Williams, 4 Cal. App. 3d 800,
810 [84 Cal. Rptr. 590, 85 Cal. Rptr. 735].)”
viii In pertinent part, CIC 1871 states, (d) Workers’ compensation fraud harms employers by con-
tributing to the increasingly high cost of workers’ compensation insurance and self-insurance and
harms employees by undermining the perceived legitimacy of all workers’ compensation claims.
iv
112288 California State Auditor Report 2002-018 California State Auditor Report 2002-018 112299
(e) Prevention of workers’ compensation insurance fraud may reduce the number of workers’
compensation claims and claim payments thereby producing a commensurate reduction in work-
ers’ compensation costs. Prevention of workers’ compensation insurance fraud will assist in restor-
ing confidence and faith in the workers’ compensation system, and will facilitate expedient and full
compensation for employees injured at the workplace.
(f) The actions of employers who fraudulently underreport payroll or fail to report payroll for all
employees to their insurance company in order to pay a lower workers’ compensation premium
result in significant additional premium costs and an unfair burden to honest employers and their
employees.
(g) The actions of employers who fraudulently fail to secure the payment of workers’ compensa-
tion as required by Section 3700 of the Labor Code harm employees, cause unfair competition for
honest employers, and increase costs to taxpayers.
ix CIC § 1872.4. Notice by insurer of belief that fraudulent claim being made
(a) Any company licensed to write insurance in this state that believes that a fraudulent claim is
being made shall, within 60 days after determination by the insurer that the claim appears to be a
fraudulent claim, send to the Bureau of Fraudulent Claims, on a form prescribed by the department,
the information requested by the form and any additional information relative to the factual circum-
stances of the claim and the parties claiming loss or damages that the commissioner may require.
The Bureau of Fraudulent Claims shall review each report and undertake further investigation it
deems necessary and proper to determine the validity of the allegations. Whenever the commis-
sioner is satisfied that fraud, deceit, or intentional misrepresentation of any kind has been commit-
ted in the submission of the claim, he or she shall report the violations of law to the insurer, to the
appropriate licensing agency, and to the district attorney of the county in which the offenses were
committed, as provided by Sections 12928 and 12930. If the commissioner is satisfied that fraud,
deceit, or intentional misrepresentation has not been committed, he or she shall report that deter-
mination to the insurer. If prosecution by the district attorney concerned is not begun within 60 days
of the receipt of the commissioner’s report, the district attorney shall inform the commissioner and
the insurer as to the reasons for the lack of prosecution regarding the reported violations.
(b) This section shall not require an insurer to submit to the bureau the information specified in
subdivision (a) in either of the following instances:
(1) The insurer’s initial investigation indicated a potentially fraudulent claim but further investiga-
tion revealed that it was not fraudulent.
(2) The insurer and the claimant have reached agreement as to the amount of the claim and the
insurer does not have reasonable grounds to believe that claim to be fraudulent.
(c) Nothing contained in this article shall relieve an insurer of its existing obligations to also report
suspected violations of law to appropriate local law enforcement agencies.
(d) Any police, sheriff, disciplinary body governed by the provisions of the Business and Profes-
sions Code, or other law enforcement agency shall furnish all papers, documents, reports, com-
plaints, or other facts or evidence to the Bureau of Fraudulent Claims, when so requested, and shall
otherwise assist and cooperate with the bureau.
v
112288 California State Auditor Report 2002-018 California State Auditor Report 2002-018 112299
(e) If an insurer, at the time the insurer, pursuant to subdivision (a) forwards to the Bureau of
Fraudulent Claims information on a claim that appears to be fraudulent, has no evidence to believe
the insured on that claim is involved with the fraud or the fraudulent collision, the insurer shall take
all necessary steps to assure that no surcharge is added to the insured’s premium because of the
claim.
x 1872.3. Investigations; Cooperation with law enforcement agencies
(a) If, by its own inquiries or as a result of complaints, the Bureau of Fraudulent Claims has
reason to believe that a person has engaged in, or is engaging in, an act or practice that violates
Section 1871.4 of this code, or Section 549 or 550 of the Penal Code, the commissioner in his or
her discretion (1) may make those public or private investigations within or outside of this state that
he or she deems necessary to determine whether any person has violated or is about to violate any
provision of Section 1871.4 of this code, or Section 549 or 550 of the Penal Code, or to aid in the
enforcement of this chapter, and (2) may publish information concerning any violation of this chap-
ter or Section 550 of the Penal Code.
vi
113300 California State Auditor Report 2002-018 California State Auditor Report 2002-018 113311
COMMENTS
California State Auditor’s Comments
on the Response From the
Department of Insurance
To provide clarity and perspective, we are commenting on
the Department of Insurance’s (department) response to
our audit report. The numbers below correspond to the
numbers we placed in the margin of the department’s response.
1
We make no such assumption. As we state on page 30, without
attempting to measure the nature and extent of the fraud
present in the workers’ compensation system, it is difficult for
the department to justify its current actions to reduce fraud, and
it is also difficult to justify any shift in the focus of such efforts.
2
As we state on pages 30 and 31, the department already has
sources available that could be used to statistically project the
types and extent of fraud present in the workers’ compensation
system. The department has the ability right now to access the
payment databases of all insurers licensed to sell insurance in
California, and by reviewing as few as 37 of these databases,
would have information on 84 percent of the state’s workers’
compensation insurance market.
3
As we state on page 34, collecting and publishing discrete
statistics of investigations, convictions, restitutions, and other
activities and using them as measures of the success of the
program’s efforts show only that some source of fraud may have
been removed from the system, but does not reveal whether
antifraud efforts have actually reduced the overall cost that fraud
adds to the system.
4
The department missed our point. On pages 34 and 35, we asked
the chief of the fraud division if the fraud commission and the
insurance commissioner had the authority to set statewide
initiatives and priorities to be used as funding criteria for the
workers’ compensation antifraud program. However, he did not
directly answer our question. On pages 43 and 44 we did state
that grant awards are not determined using standardized criteria
and that neither the review panel nor the fraud division staff
document the rationale they use in reaching their respective
recommendations for distributing the grant funds.
113300 California State Auditor Report 2002-018 California State Auditor Report 2002-018 113311
5
The department is misinterpreting what we said. We did not
recommend that the standard of evidence in the insurer referral
process be strengthened. Rather, we made the observation on
page 69 that, according to the department’s fraud division’s (fraud
division) case management database, only 3 percent of the workers’
compensation fraud referrals it received from September 2001
through December 2003 were submitted for prosecution, with a
large proportion of its closed referrals citing insufficient evidence
as the reason for closure. Therefore, it appears that the fraud
division does not receive the quality of referrals from insurers it
needs to conduct successful investigations.
6
The department is mistaken. As depicted in Figure 8 on page 70,
the fraud division’s investigators spent approximately 33 percent
of their time from September 2001 through December 2003 on
referrals that were submitted for prosecution, not 84 percent.
Furthermore, as shown by Figure 7 on page 69, the rate of case
closure for the period we reviewed is 87 percent, not 16 percent.
7
We disagree. We believe we give ample consideration to the
difficulties in analyzing the nature and extent of fraud in
the workers’ compensation system and suggest methods to
overcome them on pages 28 through 31.
8
The department’s claim that the rationale used by the review
panel to distribute funds is codified and requires no further
description or explanation is misleading. Section 2698.55 of
the California Code of Regulations specifies those elements
that must, at a minimum, be included in the county plan that
accompanies a district attorney’s application to receive a portion
of the workers’ compensation antifraud grant funds. Among
the elements required to be included in the county plan is a
description of the district attorney’s experience in investigating
and prosecuting workers’ compensation fraud, the district
attorney’s plan for investigating and prosecuting workers’
compensation fraud based on a description of the extent and
nature of the fraud problem in the county, the district attorney’s
strategy for using the grant funds to address the county’s
workers’ compensation fraud, and the district attorney’s targeted
achievements for initiating investigations and prosecutions to be
accomplished during the grant period. As we state on page 44,
the process used to evaluate the county plans submitted by
district attorneys wishing to participate in the program is based
on the individual judgments of the members of the review
panel using their own personal criteria without documenting
the reasons for their decisions. For example, some members
113322 California State Auditor Report 2002-018 California State Auditor Report 2002-018 113333
of the review panel may think certain elements contained in a
district attorney’s county plan are more important than others,
but since there is no standard scale that weights the importance
of each element, someone independent of the process used by a
review panel member could not arrive at the same result.
9
We are not recommending that referrals not be investigated.
Rather, as we state on page 69, because the fraud division closes
so many referrals citing a lack of evidence, it should work with
insurers to increase its number of referrals that are submitted
for prosecution.
0
As we state on page 51, these two sections (Sections 2693.6 and
2693.7) do not exist in department regulations.
113322 California State Auditor Report 2002-018 California State Auditor Report 2002-018 113333
Blank page inserted for reproduction purposes only.
113344 California State Auditor Report 2002-018 California State Auditor Report 2002-018 113355
Agency’s comments provided as text only.
State of California
Fraud Assessment Commission
William Zachry, Chairman
April 13, 2004
Ms. Elaine M. Howle*
State Auditor
Bureau of State Audits
555 Capitol Mall, Suite 300
Sacramento, CA 95814
Dear Ms. Howle:
Re: Response to State Audit of the Fraud Commission
My response to the audit is in three sections:
1. General comments and observations concerning the audit
2. Facts and information which is in the audit needing correction
3. A direct response to the audit recommendations
Comments and observations concerning the audit:
1
I have received a redacted copy of the audit of the Fraud Commission and the DOI Fraud Division.
Without a full copy of the audit the Commission will be unable to fully and adequately respond to
the findings.
As the newly elected chair of the Commission (December 2003) I took aggressive action to imple-
ment changes to improve the effectiveness of the Fraud Assessment Commission and the Fraud
Division.
I directed the DOI Fraud Division to work with the district attorneys to develop objective criteria for
the Commission to use to evaluate the productivity of the district attorneys.
The Commission intends to use this criterion as one of the measurables, when determining the
amount of funding that is required as well as when determining the distribution of funds to the dis-
trict attorneys and the Fraud Division.
I asked the DOI Fraud Division to submit to the Commission, their budget, and the outline of their
goals and expectations for the next fiscal year.
* California State Auditor’s comments begin on page 143.
113344 California State Auditor Report 2002-018 California State Auditor Report 2002-018 113355
Elaine M. Howle
April 13, 2004
Page 2 of 3
I asked the DOI Fraud Division to review its regulations and current audit process of the insurance
SIU operations.
I asked the Fraud Division to obtain a legal opinion to determine if the Bagley-Keene Open Meeting
Act applies to the review panel.
The DOI Fraud Division has been working to comply with these instructions.
The Fraud Commission scheduled an open forum (June 2004) of workers compensation stake-
holders and vendors (employers, labor representatives, applicant attorneys, medical providers, bill
review companies, and brokers). We will use the information from the forum to evaluate and assess
the extent of workers’ compensation fraud and the changing nature of workers’ compensation fraud.
We will also obtain information and recommendations on how to improve data collecting, report-
ing and fighting of fraud in California. We will also use this forum as a way to re-institute the fraud
advisory committee.
2
The audit did not acknowledge all of the changes or actions taken since the change of leadership
of the Commission. Nor did the audit recognize many of the improvements and changes that the
Insurance Commissioner has instituted since his election.
2
Many of the audit recommendations are initiatives, which are already underway, and I anticipate full
implementation of those in a timely basis.
3
The fundamental theme of the audit is the need to fully identify the extent and nature of fraud in the
workers compensation system. The audit states that unless the full nature and extent of fraud is
identified it is difficult to focus resources and it is difficult to measure results. I agree with the concept.
Yet in the body of the audit is the statement that fraud, by its nature, is impossible to fully measure.
This fundamental conflict detracts the effectiveness of the audit, and its recommendations. The data
4
sources, to identify fraud, recommended in the audit, contain no specific fraud identifiers.
Fraud is an evolving process. The best source of fraud identifiers and trends is the Suspected
Fraudulent Claims (SFC) process. Currently, the SFC process is weak because there are different
interpretations concerning the mandate on reporting. There is a failure of the legislature to fully
provide immunity to all who may report fraud, and because the self-insured community is largely left
out of the process, both legislatively and operationally.
The audit recommendations fails to identify the SFC process as the primary source of potential
5
fraud data, nor does it make recommendations on how to fully engage employers and other stake-
holders to report all suspected fraudulent activity.
To effectively fight fraud in California there needs to be a collaborative effort between the employers,
insurance carriers, DOI Fraud Division, district attorneys and the Fraud Assessment Commission.
113366 California State Auditor Report 2002-018 California State Auditor Report 2002-018 113377
Elaine M. Howle
April 13, 2004
Page 3 of 3
2
During the past year a number of changes have commenced to improve the planning and cost
effectiveness of the anti-fraud program. We have made many good changes and believe that we
are on the right road to having a more cost-effective program. More needs to be done and we
anticipate a positive impact from recognizing the audit recommendations.
Sincerely,
(Signed by: William M. Zachry)
William M. Zachry, Chair
Fraud Assessment Commission
113366 California State Auditor Report 2002-018 California State Auditor Report 2002-018 113377
Fraud Assessment Commission
Response to the Bureau of State Audit Report 2002-18
Workers’ Compensation Fraud: Efforts to Detect and Prevent
Workers’ Compensation Fraud Are Poorly Planned and Lack Accountability
Response Overview
Technical Corrections
(redacted version supplied to Commission)
pp. 121 Permanent disability is a separate benefit from Vocational Rehabilitation. It is technically
reimbursement for a reduced capacity to compete in the open job market. In California six out of
every ten lost time claims receive permanent disability benefits irregardless of return to work.
pp. 121 The state of California is permissibly uninsured.
pp. 131 the audit may wish to confirm the $9.5 billion in 1995 and the $25 billion in 2002. There are
differing figures and opinions on the size of the total system
pp. 131 agents and brokers and unauthorized entities also commit workers compensation fraud
pp. 181 The audit may wish to delineate how much the Fraud Division has grown from, and how
much of the staff and organization is paid for by the fraud funding.
pp. 201 The audit did not mention the 5% funding process in the audit report. That process has
specific criteria for allocation of monies to the district attorneys.
pp. 201 The audit did not mention or list the Fraud Commissions annual funding cycle calendar.
pp. 221 The California State Bar for attorneys, the licensing boards for physicians, chiropractors, and
acupuncturists, the office of Self Insurance Plans within the Division of Workers Compensation are
also data sources. However none of these data sources have any intrinsic indication of fraud.
6
pp. 271 There is no law enforcement agency in the world that has been able to accurately create
a process that will provide the assurances the audit requests; “that the assessed funds are being
effectively used”.
3
pp. 281 and 291 It is impossible to fully and accurately measure the extent and the nature all of
fraud in the workers’ compensation system. Many of the findings and recommendations within the
audit are based on the premise that it is possible to measure the amount of fraud in the workers
7
compensation system. The changing nature of fraud also compounds the problem of measuring
fraud. The audit does not tell us how can we “adequately measure and monitor the extent and
nature of fraud in the workers compensation system”. There is no police department, no state
police agency or any public safety organization that has been able to accurately determine the true
extent of fraud or crime.
1 The page numbers cited in this reponse correspond to the redacted copy of the report provided to the fraud commission
chairman for his comments. The page numbers do not, however, correspond to the report sections he references in our final
report when formatted for publication.
113388 California State Auditor Report 2002-018 California State Auditor Report 2002-018 113399
pp. 301 Malcom Sparrow’s point about focusing resources is correct, but he also stated that it is not
possible to accurately measure the true level of fraud. Crime is a subrosa event where the only
statistics, are those which are reported by the law enforcement agencies. Crime never uncovered
or reported is impossible to measure.
Criminal behavior by its nature constantly evolves towards the path of least resistance.
3
pp. 301 There is a difference between fraud and abuse of the system. This is one reason for the
difference of opinion concerning the extent of fraud in the system. The system allows employees
to regularly return to work with disability and claim a new injury for the same symptoms. This is not
technically fraud but employers perception of this activity, is that it is fraud.
pp. 301 In its funding of the 2002/2003 fiscal year, the Fraud Commission set aside $750,000 for the
Division of Workers Compensation to create such a data base. However the money was not spent
by the DWC. The Commission had no authority to independently mandate implementation of the
database.
In 1993, the employer community funded a database (the WCIS at the DIR) to assist with the
detection of fraud. This database is still not operational. The Commission has no authority to
mandate the DIR produce the database. The reporting is currently voluntarily with the insurance
companies. The suggested data format that is being developed for the WCIS is also not compliant
with generally accepted data collection formats and is inconsistent with industry practices. Please
see the California State Audit report August 2003 California Workers Compensation Program
8
pp. 321 The IRS has never had a total list of all the people who commit fraud. Many citizens
use cash and the income is never reported. If it had a comprehensive list of all the citizens who
committed fraud it would be able to stop the problem.
pp. 331 The GAO has recognized that given the sophisticated and dynamic nature of health care,
fraud detection is not an exact science. No matter how sophisticated the fraud detection techniques
used, it is unrealistic to expect to identify all fraud
9
pp. 341 The rating bureau data does not include any self-insured data. Self-insureds account for
over 24% of the employees in California. Not all employers and insurance carriers comply with ISO
reporting. This results in weaknesses in detecting fraud.
113388 California State Auditor Report 2002-018 California State Auditor Report 2002-018 113399
0
pp. 451 Since 1997, the DOI Fraud Division and the Fraud Commission have required County Plans.
These are documented needs from the district attorneys concerning their information on the cause
of fraud, the extent of the problem in their communities and their plans to fight fraud.
q
pp. 471 The Commission has reported information from the district attorneys that 85% of arrests
have resulted in convictions. The chart (figure 6 pp. 47) is incorrect.
Response to Audit Recommendations
1. Engage the Fraud Division to measure the nature and extent of fraud in the workers
compensation system
w
The Commission has requested a review of the SFC reporting process and has asked the
DOI Fraud Division to promulgate regulations that will encourage the consistent reporting of all
suspected fraudulent claims. The Fraud Commission and Insurance Commissioner Garamendi
have also supported legislation to provide immunity to all interested parties for reporting suspected
fraudulent claims to the Fraud Division.
2. Re-activating a fraud advisory committee
The Commission will work closely with Department of Insurance to reactivate a fraud advisory
committee.
3. Based on nature and extent of fraud in the system the Fraud Commission and the
Insurance Commissioner should design and implement a strategy to reduce fraud
At several meetings of the Fraud Commission, the Insurance Commissioner has shared his vision
and priorities for fighting fraud. The Commission will work closely with Insurance Commissioner
Garamendi to develop an overall strategy to reduce fraud.
4. Revamp the decision making process to determine the amount of money to be assessed.
The Commission will continue to make its decisions based on all available information. It will also
expand its source of information to include the advisory committee to determine trends of fraud
within the industry.
5. Request an annual proposal from the Fraud Division that outlines its objectives and
measurable outcomes linked to objectives from the prior year and its objectives for the
ensuing year.
A preliminary review of the budget was performed in December. A revised business plan with
measurable objectives and outcomes has been requested of the Fraud Division in January. The
Fraud Division is complying with the requests.
114400 California State Auditor Report 2002-018 California State Auditor Report 2002-018 114411
6. Revamp the reporting of the District Attorneys to better determine the appropriate
distribution of the assessed money.
This has been requested from the Fraud Division.
7. Develop and implement a process for awarding fraud assessment grants that provides
consistency among those making funding recommendations, by incorporating
standard decision making criteria and a rating system that supports the funding
recommendations.
Concur with recommendation.
8. Include in the decision making criteria how well the county district attorneys proposals
for using the assessment funds align with the strategy priorities developed by the Fraud
Commission and the insurance Commissioner.
Concur with recommendation.
9. Document the rationale for how decisions on recommendations for grant awards are
made.
w
Documentation rationale for the 5% subsequent funding is already used in the distribution process.
10. Reevaluate the Department of Insurance regulations pertaining to how indirect costs are
charged to their fraud assessment grants. Seek changes in the regulations to have all
District attorneys disclose their method and for all to follow the same formula.
The Commission has requested these changes be undertaken immediately.
11. Base recommendations for grant awards on evaluations of the submitted district
attorney plans.
e
The Commission has always included in the decision making criteria, the evaluation of submitted
district attorney plans, how well the county district attorneys proposals for using the assessment
funds align with the strategy priorities developed by the Fraud Commission and Insurance
Commissioner. In addition to above, the recommendations for grant awards have included
factors such as the cooperation of the district attorney with the Department of Insurance Fraud
Division, the frequency of reported fraud, trends in the nature of fraud, development of fraud data,
geographic, economic and population within regions and counties.
114400 California State Auditor Report 2002-018 California State Auditor Report 2002-018 114411
12. Determine whether the provisions of the Bagley-Keene Open Meeting Act apply to
the review panel’s meetings. If it does seek a specific exemption for confidential
discussions of those portions of the grants that include confidential criminal
investigation information.
The Commission has asked for a legal opinion on the application of the Bagley-Keene act on the
review panel. The panel will follow the recommendations of the legal opinion.
13. Continue the efforts to establish performance measures that can be used to evaluate the
effectiveness of the Fraud Division and the participating district attorneys
The Commission will also request the necessary legislative changes to increase the authority
funding and oversight of the DOI Fraud Division to implement necessary changes to continually
improve in the fight against fraud in the workers’ compensation system.
114422 California State Auditor Report 2002-018 California State Auditor Report 2002-018 114433
COMMENTS
California State Auditor’s Comments
on the Response From the Fraud
Assessment Commission
To provide clarity and perspective, we are commenting on
the response by the Fraud Assessment Commission (fraud
commission) to our audit report. The numbers below
correspond to the numbers placed in the margins of the fraud
commission’s response.
The chairman of the fraud commission (chairman) did not
provide his comments and perspective on our findings and
recommendations in sufficient time for us to evaluate and comment
on them in the text of our report. Although we requested that
the chairman provide his perspective on the fraud commission’s
involvement in the fraud program during the course of our audit
work, he failed to respond to most of our requests. Specifically, after
we interviewed him on February 5, 2004, to gain his perspective
on the fraud commission’s and review panel’s activities and
responsibilities in the program, we repeatedly attempted to obtain
his verification that we had accurately presented his viewpoint
through e-mails sent on three separate occasions during the first
half of February 2004, and we also left at least five unreturned
telephone messages during that same period. On February 25th he
communicated with us, but he did not provide the confirmation
we requested.
Moreover, the chairman did not respond to our request to meet
and discuss the results of our audit with him before we sent the
draft report for his review and comments. As a result, we were
unable to include most of his comments and perspectives in
our report.
Although we have not had the opportunity to review the basis
for most of the chairman’s comments, many of his comments
included under the heading “technical corrections” are not
germane to our findings and recommendations and, therefore,
we do not comment on them. However, we do have comments
regarding some of the chairman’s statements.
114422 California State Auditor Report 2002-018 California State Auditor Report 2002-018 114433
1
We provided the chairman a redacted copy of our draft report
for his review because the statutes under which we conduct our
audits preclude us from sharing the outcomes of our audit work
with the general public until we complete our work and release
our reports. Because our efforts on this audit involved multiple
state entities, we provided a redacted copy to each entity we
reviewed, including the fraud commission, that included
only the findings and recommendations from the report that
related to their respective responsibilities in the statewide fraud
reduction efforts.
2
The chairman states that we did not acknowledge all of the
changes that he and the insurance commissioner have made since
being elected. He also states that many of our recommendations
are initiatives already underway. We provided both the chairman
and the insurance commissioner opportunities to provide
their perspectives regarding the program. As for the initiatives the
chairman refers to, we saw no evidence of changes or actions
beyond what we reported concerning such initiatives.
3
The chairman mischaracterizes our report when he asserts
that the fundamental theme of the audit is the need to
fully identify the extent and nature of fraud in the workers’
compensation system, and unless the full nature and extent
of fraud is identified it is difficult to focus resources and
measure results. We make no mention of the need to fully
identify workers’ compensation fraud. Rather, on page 53,
we recommend that the fraud commission and the insurance
commissioner direct the Department of Insurance’s Fraud
Division (fraud division) to measure the nature and extent
of fraud in the workers’ compensation system and analyze
available data from insurers and state departments engaged in
employment-related activities to establish benchmarks to gauge
the effectiveness of future antifraud activities.
4
The chairman incorrectly asserts that the data sources to identify
fraud that we recommend in our audit contain no specific fraud
identifiers. On page 53, we recommend that the fraud division use
data from insurers’ paid claims databases and state departments
engaged in employment-related activities to measure the extent
and nature of fraud in the workers’ compensation system and
establish benchmarks to gauge the effectiveness of future
antifraud activities. The chairman’s assertion that these sources
contain no specific fraud identifiers undercuts the basic premise
of the Workers’ Compensation Insurance Fraud Reporting Act,
specifically, Section 1877, et seq. of the Insurance Code, which
114444 California State Auditor Report 2002-018 California State Auditor Report 2002-018 114455
requires insurers to report suspected fraudulent acts relating to
workers’ compensation insurance claims. Moreover, in March 2002
the fraud division issued its publication, Workers’ Compensation
Insurance Special Investigations Unit Guidelines and Protocols, to
aid insurers in identifying suspicious claims and the elements of
fraud in their antifraud efforts. The publication was developed by a
volunteer group that included a member of the fraud commission.
5
The audit report does contain recommendations that address the
problems surrounding insurers’ referrals of suspected fraudulent
claims to the fraud division. However, because this subject area
is the responsibility of the insurance commissioner, not the
fraud commission, we did not provide the chairman the sections
of the report that contain the findings and recommendations
related to fraud reporting.
6
We are concerned by the chairman’s statement that: “There is
no law enforcement agency in the world that has been able to
accurately create a process that will provide the assurances the
audit requests; “that the assessed funds are being effectively
used.”” When the Legislature and the governor enacted the
workers’ compensation antifraud program contained in the
Insurance Code, Section 1872.83, they authorized an assessment
on the State’s employers to pay for enhanced investigation
and prosecution of workers’ compensation fraud and created
the fraud commission to, in conjunction with the insurance
commissioner and the fraud division, determine the amount
to levy from employers each year and to determine the most
effective distribution of the assessment funds to combat fraud.
The chairman’s statement seems to imply that he does not
believe that under the fraud program the fraud commission,
insurance commissioner, and the fraud division, can ensure that
the funds the fraud commission authorizes to be provided by
employers each year are being effectively used to fight fraud. If
so, as the chairman of the fraud commission that is accountable
to employers for the funds levied against them each year, he
should seek the legislative, regulatory, or operational changes
necessary to provide that assurance.
7
We are surprised at the chairman’s apparent reluctance to
recognize the importance of measuring fraud in the workers’
compensation system. As we state on pages 27 and 28, according
to the Coalition Against Insurance Fraud (coalition), the rationale
for the consistent measurement of fraud is that you need to know
the extent of the problem to effectively solve it. The coalition
also made the point that measurement is needed to gain
114444 California State Auditor Report 2002-018 California State Auditor Report 2002-018 114455
credibility through convincing consumers and legislators that
fraud is a problem that requires remedy. Moreover, we do not
suggest that all fraud can be exactly measured. However, using
the methods we suggest on pages 30 and 31 on a consistent basis
would allow reasonable projections to be made of the amounts
of certain types of fraud.
8
As we mention on pages 28 and 29, the Internal Revenue Service
has a challenge similar to the one faced by the fraud division
with workers’ compensation insurance, in that it cannot know
the exact extent of noncompliance or fraud in the income tax
collection system, but it has used audits of statistically selected
tax returns to gain insight about the level of taxpayers’ overall
compliance with tax laws, to understand the effectiveness
of its regulations and programs, and to design a strategy for
enforcement audits that will best use its limited resources by
targeting those returns most likely to be noncompliant.
9
These statements by the chairman are confusing. Nowhere
on page 30, the page of the report he cites, do we discuss data
maintained by the Workers’ Compensation Insurance Rating
Bureau (rating bureau).
0
The chairman makes reference to county plans in his comment
regarding the fraud commission’s determination of the annual
aggregate assessment. However, he misses the point of the
section of the report. The plans county district attorneys submit
are part of the grant application package and are not available to
the fraud commission when it makes its annual determination
of the aggregate fraud assessment to be levied against the State’s
employers. Rather, as we discuss on page 41, at the time the
fraud commission makes its determination of the aggregate
annual assessment, the only information it has are the proposed
budgets that the county district attorneys are asked to provide.
These proposed budgets include only a summary of personnel
costs, operating costs, and equipment costs, and an outline of
the activities to be undertaken by the district attorney. They
do not include the numbers of cases the district attorneys plan
to prosecute or how many and what type of other activities
are planned using grant funds. Moreover, as we mention on
page 38, one of the members of the fraud commission stated at
the fraud commission’s December 2003 hearing that she was
concerned that the fraud commission was voting on the fraud
assessment amount for fiscal year 2004–05 without having
enough information to make an informed decision.
114466 California State Auditor Report 2002-018 California State Auditor Report 2002-018 114477
q
Figure 6 on page 40 was prepared using information from the
fraud division’s annual program reports.
w
The chairman’s response does not adequately address this set
of recommendations.
e
The chairman’s statements are misleading. As we state on page 44,
the process used to evaluate the county plans submitted by
district attorneys is based on the individual judgments of the
members of the review panel using their own personnel criteria
without documenting the reasons for their decisions.
114466 California State Auditor Report 2002-018 California State Auditor Report 2002-018 114477
Blank page inserted for reproduction purposes only.
114488 California State Auditor Report 2002-018 California State Auditor Report 2002-018 114499
Agency’s comments provided as text only.
California Labor and Workforce Development Agency
Victoria L. Bradshaw, Acting Secretary
801 K Street, Suite 2101
Sacramento, CA 95814
April 13, 2004
Elaine Howle*
555 Capitol Mall
Sacramento, CA 95814
Dear Ms. Howle:
This is in response to the Bureau of State Audit (BSA) draft report titled “Workers’ Compensation
Fraud: Detection and Prevention Efforts Are Poorly Planned and Lack Accountability”, which was
sent to the Labor and Workforce Development Agency and the Department of Industrial Relations
on April 7, 2004.
The findings by the BSA, indicate that improvement is needed in sharing information between State
departments to identify potential workers’ compensation fraud, that the Department of Industrial
Relations has yet to implement required programs designed to identify, report, and deter workers’
compensation fraud, and that the Department of Industrial Relations over collects and overcharges
fraud assessments from insured employers.
The Department of Industrial Relations has reviewed the findings of the BSA on this subject,
and welcomes the opportunity to provide additional and clarifying information regarding its labor
standards enforcement and workers’ compensation programs and the current efforts they undertake
to detect and prevent workers’ compensation fraud.
(1) Page 22† “Improvement is needed in sharing information between State departments to identify
potential workers’ compensation fraud.”
(2) Page 25† “The Division of Labor Standards Enforcement has not implemented a program
designed to identify employers that illegally fail to provide workers’ compensation insurance.”
The Department of Industrial Relations agrees, but wishes to provide additional information on the
work the Division of Labor Standards Enforcement currently undertakes to identify employers who
are not in compliance.
The Division of Labor Standards Enforcement (DLSE) within the Department of Industrial Relations
(DIR) has been delegated the responsibility for enforcing the State’s mandatory workers’ compensation
insurance requirements. The Division performs this function through two primary means.
* California State Auditor’s comments begin on page 155.
† The page numbers the Labor and Workforce Development Agency cites in this reponse correspond to the sections it references
from the redacted copy of the report that we provided for comment. However, the page numbers do not correspond to those
sections in our final report formatted for publication.
114488 California State Auditor Report 2002-018 California State Auditor Report 2002-018 114499
First, DLSE operates a Bureau of Field Enforcement, which is its proactive enforcement branch
responsible for conducting onsite inspections of employers’ places of business to determine
compliance with labor laws under its jurisdiction. Each of the inspections conducted by DLSE staff
includes a determination as to whether the employer has obtained valid workers’ compensation
insurance coverage or is legally self-insured. When DLSE finds an employer that is illegally
uninsured, its staff issues a civil monetary penalty and a stop notice prohibiting the use of employee
labor until insurance is obtained. It should be noted that in calendar year 2003, DLSE conducted
6816 inspections and issued 1290 citations to employers for failure to provide proof of insurance
coverage.
DLSE also operates a Wage Claim Adjudication unit that processes individual claims for wages
from workers who have been underpaid or not paid wages earned. On each of the approximately
60,000 claims filed each year, DLSE sends the employer a request for verification of workers’
compensation insurance. If the employer fails to return the requested information and is insured,
a penalty in the amount of $500 may be imposed. If the employer returns the information and
identifies the insurance carrier along with the policy number and expiration date, the information is
filed and no further action is taken. If the employer fails to return the requested information, and it is
not obtained through other means, a referral to the Bureau of Field Enforcement is made requesting
that an onsite inspection be conducted to determine compliance.
Once a citation is issued to an employer, DLSE attempts to gain compliance. Generally, voluntary
compliance is obtained through the employer’s securing of the coverage through an insurance
carrier. Once coverage is obtained, the DLSE then takes the necessary steps to collect the civil
penalty imposed for the violation.
If the employer does not voluntarily comply with the requirement to obtain insurance coverage,
DLSE will prepare a referral to the local district attorney’s office for filing of a misdemeanor violation
for failure to carry the mandatory insurance. In addition, DLSE may also request its legal staff to
file for injunctive relief with the appropriate court to force the employer into compliance and stop the
use of employee labor until the coverage is obtained.
A cited employer may discontinue business or may reopen using another name or legal entity
thereby shielding it from collection of any civil penalties assessed. The fact that it cannot operate
using employee labor without coverage, however, stops the violation for non-insurance. It does not,
however, allow the employer to open a similar business without the benefit of insurance coverage
and DLSE would take enforcement action against the new business entity.
DLSE is aggressively investigating the uninsured employer by determining compliance during every
inspection conducted and contact with employers through our wage claim adjudication process.
Each year DLSE develops an enforcement plan for the Bureau of Field Enforcement that identifies
priorities for investigations that ensure available resources will be concentrated in industries,
occupations and areas in which employees are relatively low paid and unskilled and have a history
of violations, concentrating on those industries with high rates of noncompliance with workers’
compensation insurance requirements. While the DLSE believes that the targeted program would
augment their efforts, the program cannot be implemented without the necessary funding.
2
115500 California State Auditor Report 2002-018 California State Auditor Report 2002-018 115511
DLSE does not currently have a centralized database, but operates approximately 18 different
databases making the tracking of information including repeat offenders extremely difficult.
However, DLSE is in the process of completing a Request for Proposal (RFP) and plans to
computerize its many functions and centralize its database in order to increase its enforcement
capabilities. The resulting system will allow DLSE to track repeat offenders, exchange relevant
case information with other regulatory and enforcement agencies to enhance their effectiveness,
facilitate the ability to share data and/or transfer cases, allow investigators remote access to
information, and provide the ability to track case information. This will allow the division to better
meet its mandates and increase its efficiency.
DIR agrees with the BSA recommendation to report to the Fraud Division those employers that
repeatedly fail to provide workers’ compensation insurance or benefits. Past attempts at referrals
left DLSE with the understanding that the Department of Insurance, (DOI) Fraud Division, is
primarily focused on insurers who are under-reporting their payroll or under-reporting injuries to
avoid premium costs rather than the uninsured employer. DLSE’s focus is on finding and reducing
the number of uninsured employers operating. However, DLSE will work with the DOI’s Fraud
Division to determine whether the information on cited employers would be valuable to them, and if
so, DLSE will provide the information.
DIR also agrees with the recommendation that it establish a program that uses data from the
Uninsured Employers Fund (UEF), the Employment Development Department (EDD), and the
Workers’ Compensation Insurance Rating Bureau (rating bureau). However, both the EDD and the
rating bureau have indicated that they cannot provide the requested information to DLSE without
reimbursement for their costs, estimated to be $182,000 per fiscal year. DLSE, Agency, EDD and
DOI are currently meeting to determine what information on employers would be valuable to each
and are drafting a memorandum of understanding so that this data may be shared. It should be
noted that the Division of Workers’ Compensation recently submitted a Feasibility Study Report
(FSR) to address and correct limitations in its electronic data management system. The project,
as proposed, will support and enhance enforcement against uninsured employers’, provide an
interface with the Division of Labor Standards Enforcement, and improve enforcement, training and
research activities.
(3) Page 26† “The Division of Workers Compensation Has Not Implemented a Protocol for
Reporting Potential Workers’ Compensation Fraud”
The Department, Agency and the Department of Finance have in place an active plan to remedy
this situation in operation, and DIR believes it will be brought to a successful conclusion by the time
60-day follow-up reports are to be delivered.
3
115500 California State Auditor Report 2002-018 California State Auditor Report 2002-018 115511
(4) Page 28† “THE DEPARTMENT OF INDUSTRIAL RELATIONS OVER COLLECTS FRAUD
ASSESSMENTS FOR INSURED EMPLOYERS FRAUD ASSESSMENTS FROM INSURED
EMPLOYERS”
DIR agrees with the observation that there is wide variation in assessed amounts, and accepts
the recommendation to work with the rating bureau to improve the accuracy of the current year
premiums used to calculate the fraud assessment surcharge ratio, especially in years of volatile
1
premium changes1. However the statement that the rating bureaus estimates result in over
collections is misleading. The assessment process estimates the workers’ compensation premium
in one calendar year (CY) then uses that to create a factor for insurers to charge employers in the
policies written in the next CY. It then reconciles actual premium – after the fact.
The first notice sent to insurers is for an advance fraud assessment based on the rating bureau’s
estimate of premium. At the time of the second half notice, insurers are provided with a
reconciliation worksheet, to reconcile the advance they paid two years prior with the amounts they
billed their insured employers. When an insurer has increased market share (written more policies)
in the year the surcharge is applied, many more employers will be paying--- resulting in excess
collections (but not overcharging of any employer).
The vehicle is designed to be revenue neutral to insurers over the years in collecting the surcharge
2
from insured employers. When an insurer has over paid (i.e. actually collects less than the
surcharge they paid in a year) it receives a credit on future years’ surcharges, not a refund. This
process results in the fund always having a slight surplus, except for years of severely declining
premium. Collections in excess of the amount surcharged are kept in the fund, but there are not
refunds for collections less than the surcharge, only a credit on all future years billings. The formula
for collection was developed with the rating bureau, and was last amended in 2000 to make the
approximation to premium reality somewhat more accurate.
(5) Page 32† “Industrial Relations Does Not Ensure that Insurers Correctly Report All Fraud
Assessment Surcharges”
3
The reconciliation between estimated and actual premium addresses this issue, and requires
the insurers to submit their actual premium report as a certification. If this is what the draft report
means by “verification,” it has been in place as a process since the original mechanism (form last
revised in 2003).
1
1 In the years in question, the premium measured for the assessment varied between a high of 21 billion to a low of 6 billion. Thus it
is not surprising that a system which relies on initial estimates from carriers of premium they will write, and later corrects for what
they do write, will have variations as high as 51%. Employers change carriers; Carriers terminate employers; Significant numbers
of carriers became insolvent; others withdrew from markets.
4
115522 California State Auditor Report 2002-018 California State Auditor Report 2002-018 115533
3
Department of Insurance premium tax and CIGA assessments are based on the same premium
data reports, as are reports to securities regulators (which in turn are governed by federal criminal
law, most notably the new Sarbanes-Oxley of 2002 requirement for executive certification.) If there
is evidence of substantial misstatements of premium, the issue would be far more serious than
simply the fraud assessment, and a criminal prosecution referral to the Department of Insurance
Fraud Unit should be made .
Thank you for the opportunity to review and respond to your report on workers’ compensation fraud.
It provides us with an intelligent, independent, and unbiased assessment of this issue. If you have
any questions regarding this response, please contact Marisa Duek, Associate Secretary of Fiscal
Policy and Administration or myself at 916-327-9064. Thank you.
Sincerely,
(Signed by: Victoria L. Bradshaw)
Victoria L. Bradshaw
Acting Secretary
5
115522 California State Auditor Report 2002-018 California State Auditor Report 2002-018 115533
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115544 California State Auditor Report 2002-018 California State Auditor Report 2002-018 115555
COMMENTS
California State Auditor’s Comments
on the Response From the Labor and
Workforce Development Agency
To provide clarity and perspective, we are commenting on
the response by the Labor and Workforce Development
Agency (Labor Agency) to our report. The numbers below
correspond to the numbers placed in the margins of the Labor
Agency’s response.
1
The Labor Agency is incorrect when it asserts that our statement
that the ratings bureau’s estimates result in overcollections
of the fraud assessment surcharge is misleading. Simply
put, the aggregate fraud assessment to be collected each
year is charged to each insurer by dividing the amount of
the aggregate assessment by the estimated premiums for the
current year, resulting in a surcharge factor, and applying that
quotient to each insurers’ estimated premium income for the
current year. Insurers advance their portion of the aggregate
assessment to the Department Industrial Relations (Industrial
Relations) and bill their insured employers to recoup the
advance. As such, estimates of current year premiums that are
too low result in a surcharge factor that is too high and, when
applied to actual premiums, further results in total collections
that exceed the targeted collection amount. As we discuss
on page 101 Industrial Relations regulations require that it
use the Workers’ Compensation Insurance Rating Bureau’s
(rating bureau) projection of current year premiums, in part,
to calculate the fraud assessment surcharge. As we discuss on
pages 99 through 102, recent years’ estimates of current year
premiums have been too low, resulting in overcollections of the
fraud assessment surcharge from employers, and in 1994 and
1995 the estimated premiums were as much as 51 percent too
high. Although Industrial Relations notes that increased market
share can be a source of excess collections, that is just one of
the factors, such as those factors the Labor Agency mentions in
its footnote on page 4 of its response (page 152 of our report),
to be considered when estimating total current year premiums.
Nonetheless, we are pleased that the Labor Agency agrees with
our observation that there is a wide variation in assessed amounts
115544 California State Auditor Report 2002-018 California State Auditor Report 2002-018 115555
and accepts our recommendation to work with the rating
bureau to improve the accuracy of the projected current year
premiums used to calculate the fraud assessment surcharge.
2
The Labor Agency is technically correct when it states that
Industrial Relations credits the excess amount that insurers
advance for the fraud assessment surcharge to their future
year’s surcharges, rather than refund the excess advances to
the insurers. As a result, we changed the text of our report.
However, we disagree with the Labor Agency’s characterization
that the process results in its fund always having a “slight
surplus” in collections, except for years of severely declining
premium. As we report on pages 99 through 101, for its
collection of the fiscal year 2003–04 fraud assessment from
insured employers—a year in which the targeted collection
amount was slightly more than $24 million—Industrial
Relations applied a $7 million credit to insurers for over
advances in prior years and applied a $16 million credit to
amounts to be collected from insured employers to make up
for overcollections of the fraud assessment surcharge from
insured employers in prior years. In fiscal year 2002–03,
Industrial Relations had accumulated $10 million of excess fraud
assessment surcharges that it had collected in prior years.
3
The Labor Agency misses the point of our finding when it
states that reconciling estimated premiums to actual premiums
addresses the issue, and its following discussion of premium tax
and assessments is not relevant to our finding. As we discuss
on page 102, our finding is based on suspicions that Industrial
Relations’ staff have that some insurers may not be reporting and
remitting all of the fraud assessment surcharge they collect from
insured employers, an amount its staff estimates ranges from
$8 million to $13 million during 1999 through 2001. Industrial
Relations does not believe it has the statutory authority to verify
the accuracy of the insurers’ reconciliation statements.
115566 California State Auditor Report 2002-018 California State Auditor Report 2002-018 115577
cc: Members of the Legislature
Office of the Lieutenant Governor
Milton Marks Commission on California State
Government Organization and Economy
Department of Finance
Attorney General
State Controller
State Treasurer
Legislative Analyst
Senate Office of Research
California Research Bureau
Capitol Press
115566 California State Auditor Report 2002-018 California State Auditor Report 2002-018 115577